Elements of Financial Planning, Part 3: Insurance and Estate Planning

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Elements of Financial Planning, Part 3: Insurance and Estate Planning

Risk management and estate planning are important parts of every financial plan. There are many types of risk addressed in a well-drafted financial plan – risk caused by stock market declines, economic instability, death, disability and loss of income. These unforeseen events can have devastating financial implications to finances and alter the anticipated outcome of a financial plan. While risk is impossible to avoid, risks like death, disability and loss of income can be managed appropriately through insurance. Insurance should be used to transfer risk that has a low probability but with high financial consequence.  In a well-crafted plan, all forms of insurance should be considered, reviewed and implemented where appropriate.

The premature death of a family member can have a major financial impact to survivors and loved ones.  It is important to insure the economic void that would be created in the event of death through life insurance. Calculating the present value of future earnings that would otherwise be lost is a prudent first step. Term life insurance policies are the least expensive and typically cover the income earner over their years of employment and potential lost earnings. Similarly, disability can cause major financial hardship, yet disability insurance is often overlooked. If the primary income earner in a family is unable to complete their work duties, the financial loss can be devastating. Depending on an individual’s age, the risk of disability is greater than the risk of death and can create the same financial loss to the family.

Long-term care insurance helps to pay for the cost of long-term care that is not covered by health insurance, Medicare or Medicaid. Individuals who need long-term care may not be able to dress, bathe, walk, or eat by themselves. The insurance covers facilities such as assisted living, home care, hospice, nursing homes, etc. Long-term care has become increasingly important as people live longer.  However, we believe Long Term Care is often unnecessary and over sold.  If someone has a net worth of over $2 – $3 million, they can typically self-insure for the most common long-term care needs.  In addition, long-term care coverage can be quite pricey and is often not used at all so we suggest you speak to your financial planner about whether to purchase coverage.

Along with risk management, estate planning is a critical piece to a comprehensive financial plan. It encompasses arranging for an individual’s estate during life and after death.  Estate planning involves having documents in place to ensure that one’s wishes are met in the event of death or incapacity.  In addition, a financial plan can help mitigate or eliminate the death tax associated with large estates.

The first step in a sound estate plan is establishing a revocable living trust. During the grantors life, a revocable trust is amendable and all the assets and income within the trust are available to the grantor.  After the grantor dies, the trust becomes irrevocable and dictates how the assets are distributed to various beneficiaries and avoid expensive and lengthy probate proceedings.  It also typically includes language for naming guardians of minor children, directives for end-of- life medical care, assigns power of attorney for financial decisions in the event of incapacity, and names representatives for health care in the event an individual is unable to make decisions.  All the assets in a revocable trust are included in the grantors estate for estate tax purposes so there are no tax advantages. For high net-worth individuals, more sophisticated planning is often needed to avoid or reduce estate taxes.

Spreading gifts throughout one’s lifetime is a great strategy to help reduce estate taxes. Currently, one can gift up to $14,000 per recipient per year and make direct payments to medical and educational providers on behalf of loved ones free of any estate or gift taxes. Each individual can transfer $5.49 million during life and/or at death. In other words, under current law you can give away up to $5.49 million during your lifetime, above the annual $14,000 exclusion and any payments made directly to medical and educational providers on someone else’s behalf—and still avoid gift tax.

When large gifts are made, grantors will typically set up an irrevocable trust as the recipient of the gifts.  Unlike outright gifts to beneficiaries, gifting to an irrevocable trust allows the grantor to set parameters on how and when the funds are accessed.  It can also offer another layer of creditor protection for the beneficiaries if set up properly. When the beneficiaries are minor children, it’s common to see provisions allowing the children access once they reach adulthood.  It’s also common to see these trusts being funded with permanent life insurance based on the grantor(s) life.  The death benefit pays the trust tax free upon death of the grantor(s).  This is referred to as an irrevocable life insurance trust.

Charitable giving is a good way to reap tax benefits, make a positive contribution to society and can be a useful strategy for high wage earners. Ideally, you’d want to gift in a year when you have substantial income at the highest taxable rate. An individual can gift either cash or securities (or other assets), though there are distinct benefits to gifting appreciated securities. If an individual has an appreciated stock position and is inclined to charitable gifting, it may make sense to gift all or a portion of the stock so that you can get a tax deduction and avoid paying capital gains tax. You would essentially get all of the asset’s appreciation out of your estate and receive a deduction.  It may be beneficial to use a Donor Advised Fund or a Charitable Remainder Trust (CRUT) as part of your gifting strategy. More information on both of those vehicles can be found here.

A customized, well-designed financial plan brings clarity and direction to financial choices clients make every day. Two important elements of a financial plan are risk management and estate planning. Though it is important to manage risk and minimize taxes through prudent planning, it is never possible to avoid them altogether (only in some cases can estate taxes be completely avoided). The peace of mind offered by a well-constructed financial plan is invaluable to help clients navigate periods of market volatility and stay on course in achieving financial goals.

Disclaimer: Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at www.adviserinfo.sec.gov.

By | 2017-08-21T18:04:45+00:00 August 21st, 2017|Financial Planning|

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