Come to Terms with Estate Tax Concerns

Timothy Smith, MD, a surgeon inHollywood, Fla, has a significantestate tax of $5 million. Recently,the 52-year-old divorced father of threebecame concerned about estate taxesand began shopping for a life insurancepolicy to solve the financial problem.

To complicate matters, there wasanother concern. The Economic Growthand Tax Relief Reconciliation Act of 2001gradually repeals the estate tax over a10-year period. Unless Congress acts, onDec. 31, 2010, the tax laws will revertback to the 2001 rules. Given the temporarynature of the estate tax legislation,what should Dr. Smith do?

Covering the Bases

Dr. Smith must devise a plan that benefitshim no matter what happens withthe estate tax. To do this, he can createan irrevocable life inusurance trust andfund it with an insurance policy. The followinglist provides insight into someinsurance alternatives:

•A 20-year level term policy. Assuminga premium of $12,000 a year, shouldDr. Smith live through age 72, the problemstill remains. On the other hand,should the estate tax go away after2010, Dr. Smith's 5-year out-of-pocketexpense will be $60,000.

The problem:

•A universal life policy. Designed tooffer flexibility, a percentage of the premiumpaid will go toward building cashvalue. It does so on aninterest-sensitive basis set by the underwriter.The result is that the premiummoves up to $56,240 a year. Should thelaws in 2010 favor Dr. Smith and he nolonger has an estate tax liability, his 5-year net out-of-pocket expense will be awhopping $205,326 (gross premiumspaid for 5 years less the projected cashsurrender value of the policy).

•A variable life policy. A percentageof the premium will be invested in mutualfund subaccounts. Assuming an 8%gross rate of return, the premium will be$68,240. Once again, should the laws in2010 favor Dr. Smith and he no longerhas an estate tax liability, his 5-year netout-of-pocket expense will be $143,095.

Options within Options

As you can see, all three policies havehigh out-of-pocket fees, which is a problemshould the estate tax go away. So, isthere another solution? Yes, there is.

You may not be aware of it, but surrendercharges may be waived, terminsurance can be blended into the policyto lower costs, and an agent's commissionmay be spread out over a period ofyears as opposed to being paid in full upfront. This will substantially reduce policycosts, resulting in higher cash accumulationswithin the policy.

The bottom line:

The cost to fund a properly designedvariable life policy worth $5 million canbe lowered to $55,343 a year. Should thelaws in 2010 favor Dr. Smith and he nolonger has an estate tax liability, his 5-year net out-of-pocket expense will thenbe only $24,127. As you can see from thisfigure, it's worth considering a properlydesigned policy. Youneed to be prepared should the estatetax stick around or go away and lifeinsurance can help.

and his

partner, Harris L. Kerker, are principals

of the Asset Planning Group

in Miami, Fla, specializing in

investment, retirement, and estate

planning. Mr. Kosky teaches corporate

finance in the Saturday Executive and Health

Care Executive MBA Programs at the University of

Miami. He welcomes questions or comments at

800-953-5508, or visit www.assetplanning.net.

Thomas R. Kosky, MBA,