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Diversifying A Concentrated Stock Position With Life Insurance

Some of your clients have concentrated stock portfolios they won’t need for retirement income during their lifetimes. These portfolios may range from individual shares of one publicly traded company, to shares of stock in multiple publicly traded companies, to a variety of stocks in a specific mutual fund. These portfolios may be personally owned or they may be owned by an irrevocable trust. These clients may be worried that a significant market downturn of the type the U.S. experienced in 2008- 2009 could wipe out 30 to 50 percent of the equity value of their share holdings.

As we surpass the market top last reached in the late 2007, could an overextension of stock holdings portend a déjà vu collapse of the stock bubble? In the words of former Fed chief Alan Greenspan, are we now in the midst of another period of “irrational exuberance?”

If your clients are starting to ask you about spreading their financial risk because they fear another downturn, you can ease some of their fears by providing them with a financial solution that increases the overall stability of their portfolio, increases the value which will be inherited by their heirs, eliminates or diminishes market volatility and provides a guaranteed tax free benefit.

What we are talking about is diversifying the stock portfolio by repositioning a portion of the portfolio into a single pay guaranteed no-lapse universal life policy with a competitive and highly rated carrier. The net increase in the amount inherited by the heirs can be significant for those that want to provide a legacy for their family. And the tax-free financial leverage provided by life insurance is extremely attractive in this continuing low-interest rate environment. Take a look at the case study below to see how this diversification can be accomplished.

Hypothetical Facts and Results of Diversifying a Concentrated Stock Position

Mr. and Mrs. Johnson are each 65 and are entering their retirement years. They own 20,000 shares of ABC publicly traded stock with a current price of $50 per share = $1 million. The original cost basis is $200,000 ($10 per share). Their 2013 taxable income is projected to be less than $450,000, so they will pay any capital gains taxes at a federal rate of 15 percent. They will sell 10,000 shares (50 percent of their shares), pay the capital gains taxes, and place the after-tax cash proceeds into single pay no-lapse survivorship universal life (SUL) with preferred underwriting from a competitive and highly rated carrier. Here are seven steps:

  1. Sale of 10,000 shares of ABC stock @ $50 per share = $500,000.
  2. Capital gains taxes (20 percent combined federal/state) on gain of $400,000 ($100,000 cost basis) = $80,000.
  3. Net cash after stock sale and capital gains taxes = $420,000.
  4. Use $420,000 to purchase a Single Pay Guaranteed Death Benefit SUL policy = $1,803,000 face amount.
  5. Value of remaining 10,000 shares of ABC stock @ $50 per share = $500,000.
  6. Total current value that may be inherited by heirs = $2,303,000.
  7. After-tax IRR on tax-free death benefit @ Joint Life Expectancy in year 25 (Ages 90/90) = 6.01 percent.

What IRR would the non-guaranteed stock have to generate in order to equal the guaranteed death benefit of the no-lapse SUL policy? The 10,000 shares of stock would have to grow from a current value of $50 per share ($500,000) to a future value of $180.30 per share ($1,803,000) to equal the death benefit of the SUL policy in 25 years (age 90/90 joint life expectancy). That’s a non-guaranteed IRR of 5.27 percent over a 25-year period and it assumes that at least one of the insureds will live to at least age 90. The 25-year period in this example is the joint life expectancy for the 65-year-old husband and the 65-year-old wife from Table VI of Treasury Regulations 1.72-9.

The guaranteed tax-free actuarial leveraging of the SUL policy immediately provides a superior financial result that the non-guaranteed ABC stock will have difficulty matching over the 25-year time frame, especially if a bear market occurs near the end of the 25-year horizon. In effect, some of the investment risk over the next 25 years has been transferred to the insurance carrier in exchange for a single premium of $420,000.

(Please note that the single-pay SUL policy in this example is a modified endowment contract [MEC]. Death benefits from MECs are income-tax-free just as death benefits from non-MECs are income-tax-free.)

That’s a $1,303,000 increase in the current value of the inheritance for the heirs of the client by adding a guaranteed no-lapse SUL contract to their portfolio with no additional market risk.

Depending on the size of the gross estate of Mr. and Mrs. Johnson in our example above, the $1,803,000 Survivorship UL policy may or may not be owned by an irrevocable life insurance trust (ILIT). After the passage of the American Taxpayer Relief Summary of current Concetrated Stock Position c Diversified Life Insurance PlanAct of 2012, the federal estate tax exemption in 2013 is $5,250,000 for an individual and $10,500,000 for a married couple. If the $1,803,000 death benefit could be exposed to estate taxes if the SUL policy is owned personally and included in their gross estate, then an ILIT could be the initial owner and beneficiary of the policy to keep the death proceeds estate-tax-free. If the value of their gross estate plus the $1,803,000 Survivorship UL death benefit is still less than the estate tax exemption threshold, then owning the policy personally may be a good choice so that they keep control over the policy without the need for an ILIT.

However, even if their gross estate will not exceed the 2013 estate tax exemption, Mr. and Mrs. Johnson may still consider the use of an ILIT for the following reasons: the death benefit of $1,803,000 is sufficiently large enough to warrant professional money management by a trustee acting as a fiduciary for their heirs, there could be state death taxes ranging from about 5 to 16 percent depending on the state death tax exemption available in the state where they reside, and there could be post-death income taxes for their heirs on the value of any remaining Individual Retirement Account (IRA) funds inherited by the heirs of Mr. and Mrs. Johnson.

No matter which ownership plan the Johnsons choose for their policy, personally owned or owned by an ILIT, the death benefit remains income tax free. And their minds will have been placed at ease knowing that their heirs will be guaranteed to inherit at least part of their stock portfolio without any further market risk. The plan described here provides a nice balance.

Part of their portfolio is still invested in stocks to take advantage of non-guaranteed future growth of the remaining equities and part of their portfolio has been taken off the risk table in the form of a guaranteed no-lapse SUL insurance policy. It’s a strategy guaranteed to leave your clients rationally exuberant.

Russell E. Towers, JD, CLU, ChFC, is vice president, business and estate planning, of Brokers’ Service Marketing Group. Contact him at [email protected] [email protected].


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