On the horns of a dilemma…

Case Facts:

Henrietta Mater is a cheery 95 year old widow with no living heirs – and significantly diminished cognitive abilities. For this reason, she is being represented by both a respected private fiduciary with a financial power-of-attorney (POA) and a noted estate planning attorney.

Her quality of life was quite comfortable prior to her mental deterioration, and it currently costs $22,000/month in care to maintain that quality of life. At this rate, her assets will last approximately 3 ½ years. Her life expectancy is uncertain, and the fiduciary does not have a healthcare POA without going to court.

Over the years Ms. Mater has been a consistent giver to charities. In fact she felt so close to her two favorite causes that years ago she bought a life insurance contract for $675,000 to be split between the two. The insurance company told the fiduciary that premiums of $45,000/year are required to maintain the contract. If no further premiums are paid, the cash value is projected to be zero within two years. The cash value, if surrendered today, is approximately $200,000.

Concerns Raised by the Fiduciary:

  • Can they realistically continue life insurance and meet Ms. Mater’s objectives to benefit her two charities, while her healthcare costs continue at $22,000/month?
  • Are there other options besides paying $45,000/year in life insurance premiums to address Ms. Mater’s philanthropic wishes?
  • Would they be better off surrendering the contract and receiving the $200,000 today … or have it depleted within two years if no further premiums are paid?
  • Are there other options that they are unaware of that should be considered?

With this as a backdrop, the private fiduciary and attorney engaged Wealth Legacy Group’s Insurance Analytic, and together we discovered:

Discoveries & Observations:

  • The life insurance contract has a special provision… as long as there is $1 in cash value at age 100, no further premium is required. We projected that by paying $22,500 at current rates of return, we could meet the target objective of $1 at age 100 … thus cutting the required premiums in half.
  • We considered a new option… selling the contract on the open or secondary market. By negotiating with potential buyers given various health classifications, we were able to determine that private pools of capital would buy the contract for between $265,000 and $450,000… well above the $200,000 surrender value. Because a life expectancy report would be required to pursue this option, the fiduciary must decide if it is worth going to court to obtain the necessary healthcare POA.
  • We also discovered several annuities in Ms. Mater’s portfolio. Other advisors suggested that they be cashed in and used to pay her expenses. However, given the earnings of the annuities since the original deposit, this would create a taxable event. Health care costs would likely absorb some or all of the income. Another option, however, would be to wait until she is receiving institutional care, at which point the annuities would provide a tax-favored distribution stream. Further, had she been able to pass a cognitive test, Ms. Mater would have been able to substitute her annuities for an annuity that qualifies under the Pension Protective Act of 2006. Starting in 2010, annuities having this special language allow for withdrawals for healthcare or the payment of long term care insurance – completely tax free!
  • What came next was a surprise to us all … the beneficiary on the life insurance contract was Ms. Mater’s B Trust. This was apparently done to provide flexibility in paying benefits should her charities cease to exist or should she change her preferences over time. Unfortunately, this beneficiary design meant there was NO deduction permitted for the $375,000 premiums paid thus far! If the two charities were irrevocably named today, she would get a deduction for the current cash value… a deduction she really doesn’t need given her healthcare expenses. Ten years ago, however, that deduction would have been significant. With the desire to allow flexibility in charities, a Donor Advised Fund could have been established at a Community Foundation or National Foundation. This design would have given an immediate tax deduction of up to 50% of her adjusted gross income if cash was donated. If the deduction was too large to be taken in a single year, there would have been an additional five years to take the excess deduction. And, if she changed her mind about the charities or they ceased to exist, another charity could be easily substituted.

What Can We Apply From This Case:

The aging of America and inadequacy of previous trust services have dramatically accelerated the need for and use of private fiduciaries. As this case illustrates, the role is difficult, and the challenge is to know what questions to ask. Where can they go to find objective and knowledgeable advisors to provide counsel in insurance and planning matters? Fortunately for Ms. Mater, her fiduciary and attorney were wise enough to recognize the need for outside counsel in exposing and then evaluating the various options… some known and some previously unknown. More than ever, it is “mission critical” to have a diversified team of advisors and professionals to uncover, consider, implement and review the best products and solutions available… some of which didn’t exist as recently as a year ago.

Imagine that!

Written by R. J. Kelly – April 2011

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