I often hear people wonder about how much life insurance costs. They misunderstand meaning. After decades of experience I have decided that the question is wrong. Insurance costs nothing.
That of course does not mean that the insurers will stop taking money from your bank account. It means that people have confused the answer with the question. As we have discussed before if you define a problem poorly, you will seldom get an optimal answer.
These are problems that arise at death:
- The estate deficiency problem. Survivors will need more to allow their lives to develop as intended.
- The estate equalization problem. Dominant assets (usually a family business, a farm, heirlooms) must pass to one of several children.
- The estate liquidity problem. Cash for taxes, charity, debt repayment, costs of the estate but all the assets are illiquid.
- The wrong ownership of asset problem. Some assets are in corporations and would be better out.
All of these can be quantified. The amount that results is the cost of that particular problem. The problem defines the cost.
There are solutions. None of them are costs, but merely ways to pay the cost that arose in the problem section.
There are precisely four ways to deal with the estate problems above. Each of them can be analyzed to determine the commitment of resources that a person would need to solve the problems. Of the solutions, executors will control two of them and the deceased will have controlled the other two.
The executor controls:
- Sell something. The executor year is an issue for income tax purposes so urgency appears. When you must sell, you sell what you can not what you want. “Estate Sale” is a synonym for bargain. Sell the best assets for too little.
- Borrow. From whom and on what terms. Tie up at least $2 of the estate for every $1 raised. Non-deductible interest. May eventually be forced to sell assets anyway. Usually a long time until assets are paid out to heirs.
The deceased controlled:
- Own liquid assets that pass to the estate. May be too few in the early years of the plan. To be liquid and to have a predictable value requires a give-up on the yield side. All income is highly taxable.
- Own life insurance. Meets the need from day one. Growth is in a tax preferred environment. Cash in 30 days or so after death.
If I have a problem, my correct moves are.
- Minimize the problem. Better tax planning or better distribution plan. Talk to an accountant and lawyer. Define the irreducible minimum problem.
- Find the way to resolve that problem while minimizing the capital I must employ to deliver the solution. Each solution can be analyzed on a capital employed basis.
Minimizing the problem and optimizing the solution provides the greatest estate.
Hint: Life insurance is provably least costly.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
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