What is a high-net-worth individual?
High-net-worth individuals (HNWI) are usually defined as having at least $1 million to $5 million in investable assets. The threshold might be higher depending on your location, life stage and liabilities.
High-net-worth financial planning takes into consideration the needs of this group. Rather than focusing mostly on building assets, high-net-worth individuals have often shifted their primary concern to preserving their wealth and passing it along. That’s where life insurance can be a valuable tool.
“Once you start to have maybe $2 million in investable assets, you start to potentially have the luxury of being able to think about other things that life insurance has the versatility to be able to help you with, like leaving a legacy,” says Vaughn Bowman, head of wealth management with MassMutual and CEO of MML Investor Services, MassMutual’s broker/dealer and investment adviser subsidiary.
7 key goals for HNWI life insurance planning
Life insurance for wealthy individuals can help with needs other than income replacement.
1. Building a legacy for future generations
Buying a life insurance policy can provide a legacy for future generations. “A lot of high-net-worth families are not just thinking about generation two, but also generation three,” says Michael Amoia, vice president of advanced markets for Valmark Financial Group, a financial services company based in Akron, Ohio. Amoia works with many clients who are 65 and older and have well over $10 million.
Life insurance can be a more tax-efficient way to leave money to grandkids than making them the beneficiary of your retirement-savings accounts, like IRAs, where they’ll have to pay taxes on the earnings when they withdraw the money (and, thanks to the SECURE Act, they can no longer spread the inherited IRA withdrawals over their lifetime). Life insurance death benefits, on the other hand, are paid out income-tax free. “It provides tax diversification,” he says.
Amoia tends to look at these types of life insurance to help clients reach this goal:
Survivorship life insurance. This type of joint life insurance policy has lower premiums than buying two separate policies because it pays out only after the second spouse dies. Premiums tend to be about 1% of the face amount for survivorship policies for two 65-year-olds in relatively good health, while single-life premiums are about 2% of the face amount, he says. “At 1% per year in face value, it is very strong leverage,” he says.Guaranteed variable universal life insurance (VUL). Guaranteed VUL lets you invest the cash value in mutual fund-like accounts but guarantees that the policy won’t lapse as long as you pay the required premiums. Amoia chooses death benefit Option B (called Option 2 at some life insurance companies), which gives your beneficiary the death benefit plus the cash value when you die. His high-net-worth clients usually don’t need to tap the cash value while they’re alive and focus on leaving the most money to their heirs.
2. Extra source of emergency funds
Even if you buy life insurance primarily for the death benefit, it can serve other purposes. For example, you can borrow money from cash value life insurance tax-free if you need an extra source of cash, so you might not have to keep as much money on hand for emergency expenses.
It can also give you an alternative to selling investments during a market downturn.
Because of the “sequence of returns risk,” having to take investment withdrawals during a downturn early in retirement can reduce your savings for the rest of your life, which happened to many people who retired in 2008. “If you have another source of liquidity in the form of the cash value of a life insurance policy, you don’t feel the pressure to sell,” says Bowman. “When you read about market headlines, you are a little more secure knowing you have another thing you can tap into if you need to.”
Bowman usually uses whole life insurance for this purpose. “That is something that tends to behave over time a little more like a bond, and it has the stability of the dividend and the cash flow and it doesn’t depend on the market,” says Bowman. “We always make sure to evaluate the need with the life insurance death benefit first and foremost, but with high-net-worth individuals it does provide ancillary benefits.”
You can pay back the policy loan after the market rebounds and restore the full death benefit.
3. Estate planning
Federal estate taxes apply to estates larger than $15 million per person and they are a significant concern for high-net-worth individuals. Spouses can pass an unlimited amount to each other and delay estate taxes until the second spouse dies, but then the portion above the threshold is subject to estate tax, which can be as high as 40%.
Buying life insurance for estate planning can provide your heirs with a death benefit to help pay those taxes without having to sell other assets. “A great example is somebody who is rich in land,” says Nathan Schelhaas, senior vice president, benefits and protection for Principal Financial Group. “There might not be huge cash flow, but when they leave that land to their heirs there will be taxes. Having life insurance to pay taxes so they don’t have to sell land is something that the high-net-worth person is thinking about.”
You might be subject to state estate taxes with fewer assets, depending on where you live. Some states, such as Oregon and Massachusetts, have state estate-tax thresholds of just $1 million or $2 million.
