Only When Pigs Fly: A Leaner Perspective of Life Insurance
Frankly, I was appalled. Let's see what you think . . .
An insurance agent approached a 50-something, third generation owner of a minority interest in a family business to reexamine life insurance needs. The owner, who we'll call "Jim," was about to conclude a nasty divorce that would leave him with the stock, but not much else. He wanted to make sure that estate taxes would not force his children to sell the stock at the low price under the family's buy/sell agreement. Jim also wanted to make sure that his kids could get through school.
The agent took Jim's balance sheet information, extrapolated values for the next 30 years, and calculated the shortfall in funds available to pay estate taxes. He then proposed a $10 million variable life insurance contract that would mostly cover the estate tax on the projected stock value. "Better hurry," he said. "The insurance company just discontinued this policy because it's too good. But I know the underwriter and got a two-week extension for you to buy it."
Seems reasonable for Jim to grab the insurance, right? In my humble opinion, the answer is, "Only when pigs fly!"
Now, I am not impugning this agent's ethics because there certainly is room for differences of opinion. Plus, he may not have asked for or received all of the information to properly address the matter. But, like Jim, most normal folks are sufficiently confused by life insurance and the sizzling sales pitches to warrant a few Professional Insights columns on the subject. Perhaps I can help save your bacon.
Take a Deep Breath
I didn't appreciate the agent's pushiness. A life event, like a divorce, certainly is an appropriate occasion to review your estate plan. However, just as most investment advisors recommend that you take your time before investing a lottery windfall, you should take a deep breath before making a big insurance purchase or taking some other major step when a divorce or other life event occurs.
The chances that you will be struck by lightening while thoughtfully considering a major insurance purchase are rather remote. The chances of being taken advantage of or making a mistake are far greater. Just as for other major purchases, we should be wary of high-pressure sales tactics. Perhaps Jim should forgo the once-in-a-lifetime opportunity to think through his alternatives.
Overall Budget Considerations
If you have more money than you know what to do with, premium cost is not a consideration. The rest of us need to consider alternative uses for the money.
The agent asked for and was told Jim's discretionary cashflow, meaning income in excess of expenses. The $125,000 proposed annual premium equaled Jim's available cash and happened to buy just the right amount of insurance to pay projected estate taxes. Isn't that amazing? (More on this coincidence later.)
The agent didn't really focus on Jim's other budgetary needs. Perhaps Jim needed to do some subjective weighing of conflicting objectives. While one objective was to pay estate taxes, he also wanted to enjoy life a little (meaning increase his living standard modestly) and to rebuild some of the financial assets that were sucked away by his departing spouse and the lawyers.
More insurance means fewer potential problems at death, but less comfort and financial security while alive. Sometimes, we just can't afford everything we want, so we consider and make trade-offs and compromises. Jim's life needn't be a total sacrifice; maybe the kids can stretch a bit, too.
Funding the Tax over Time
Remember Jim's specific objective - avoiding forced sale of family business stock? There are alternatives to insurance. Think of the estate tax as borrowing money from Uncle Sam. The stock and other assets are collateral for the debt. The oft-used insurance scare tactic is that the debt must be paid nine months after death. However, Uncle rarely demands immediate payment by sacrificial sale.
In fact, Jim's agent failed to point out that the law allows up to 15 years for payment of estate tax on closely held business interests, with quite low interest rates. Jim's family's business pays dividends that could fund much of the tax and interest over that time frame. Of course, there is a risk that the dividends could be reduced, but they certainly shouldn't be ignored as a funding source.
Duration of Need
What about Jim's desire to make sure that his kids are supported and can finish school? Isn't that objective shortchanged if all of the dividends must be used to pay taxes? Sure. However, given his kids' ages, cash will be needed for their support for only about five years. After that, Jim believes the kids should be left substantially on their own to provide for themselves. He just doesn't want them to have to sell the stock.
Supporting dependents is a legitimate reason to buy insurance. The agent proposed "permanent" insurance. However, Jim's kids have only a short-term need. On your next business trip, would you buy a car just to get from the airport to the hotel?
So, my initial beefs with the agent's proposals were the urgency of the sales pitch, the total disregard of other lifetime cash needs, the failure to consider available time to pay estate taxes, and the lack of focus on the duration of the need for insurance. I squealed, and Jim decided to take a deep breath.