If you are considering a large tax-exempt permanent life insurance policy as part of your estate plan, read this first.
For over 20 years my primary revenue source was selling life insurance, so I write on this topic with some experience. I also built financial plans and managed investments, but life insurance commissions paid the bills. I now choose to operate as an advice only financial planner. I specialize in estate, succession and transition planning for families and family businesses and very often, my clients use life insurance. It can be a very effective tool in support of their business and financial goals. I choose, however, to get compensated from my clients directly now so that I do not have a financial bias towards any particular strategy. The insurance commissions go to the insurance advisor.
More on those commissions below.
First what are some of the benefits of tax-exempt permanent life insurance anyway?
Having tax free cash flow in very shortly after death can be very helpful in estate planning. For example, if your estate plan includes a family business some of your heirs maybe interested in taking over and others may not. Life insurance can be a very effective tool to fund an inheritance for the non-business beneficiaries.
That same liquidity provided by life insurance can be helpful in covering tax liabilities on family business assets or on other family enterprise assets. An investment portfolio, a family cottage or other real estate may be subject to capital gains tax on the death of a tax payor. Depending on the ownership structure, tax will need to be paid before it can transfer to an intended beneficiary. If the beneficiaries intend to keep those assets, life insurance can provide the cash needed so that the assets do not have to be sold to cover the tax bill.
There are many other benefits to tax-exempt permanent life insurance, we’ll leave that for another article.
Back to the commissions. How much does an advisor earn for selling a policy?
23 years ago, if clients committed $10,000/a into a policy, I would receive between $10,000 and $15,000 in that first year for selling the policy, depending on the type of policy and on how much business I had written in the previous 12 months. That’s not a typo, I was paid more in the first year than the total premium paid by the client. For the remainder of this article, we’ll be referring to permanent life insurance (universal life or whole life).
This was to compensate me for four things:
- Finding the client
- Determining the insurance coverage needed
- Transacting – helping the client apply for the coverage
- Servicing the policy going forward
Remember those four things.
If that policy did not last for more than three years, I would be charged back the commission that I earned in that first year. If you’ve purchased a large life insurance policy and stopped hearing from your advisor after three years, that may be why. You may also find it fun to call your advisor 2.5 years into a large policy and let them know you are considering cancelling the coverage. You will receive a lot of positive attention from your advisor in support of keeping the coverage in place.
Premiums on larger permanent life insurance policies are often six or seven figurers and the commissions can be the same as detailed above.
That’s right, if you put $1,000,000/a into a tax-exempt permanent life insurance policy, your advisor may get paid up to $1,500,000 in the first year.
It is important to note that most permanent policies, both Universal Life and Whole Life, provide the opportunity to add additional deposits. The commission on these additional deposits is significantly less than on the base premium. The tax sheltering and growth that can build in these policies can be very attractive. Advisors that structure policies for their clients with additional deposits will have the benefits of knowing their clients are using a potentially very beneficial financial tool, however their commission rate will be significantly reduced.
If you’re thinking these commissions are little rich, it depends on the advisor and the situation. Some advisors earn every penny of their compensation. More on that below.
First, the bad actors. Some “advisors” have entered that industry to make money. Helping clients was a secondary or tertiary objective, or sometimes not their objective at all. Those advisors know people, or find people, who may need life insurance (Finding). They lean on insurance companies’ internal resources or tax or legal advisors to do the analysis (Determining) and lean on insurance companies to do the Transacting. Once the policy is in place, they don’t do any Servicing, especially after the three-year mark.
Many of these “advisors” drive very expensive cars and are members at very important clubs. Many of them even have fancy credentials and maybe even some white hair to add to their credibility. None of these things are bad in the presence of a moral compass that steers one towards working in their clients’ best interest.
However, if these wonderful qualities are solely used to convince people with a pulse and some pent-up cash in a family business or holding company to buy into a complex structures that includes life insurance policies that they may or may not need so that the advisor can keep driving the expensive cars and being a member at expensive clubs, you may have a bad actor. These advisors are less likely to build a policy in a way that is best for you.
Avoid the advisors that package up and sell very complex and risky structures as cure-all’s for too much tax in your family business or in your life. Leverage, trusts, holding companies and insurance can certainly be combined in the right proportion to create some tax success, but every business and every family is different. Buying a pre-packaged combination of these structures is, in this planner’s opinion, the best way to make your advisor rich and risk a CRA audit. It’s the worst way to build a plan that prioritizes your objectives.
Who are the good actors?
There are a lot of them. In situations where large tax-exempt permanent life insurance policies are placed, there is often complex planning required. There may be holding companies, operating companies and trusts. There may be international tax considerations and leverage. A good insurance advisor may be the conduit that drives the collaboration required between tax, legal and financial advisors. They may also be the advisor responsible for the hard work of identifying and quantifying the need (Determining) and applying for the coverage (Transacting) and this process can take months and often years.
Once that policy is in place, good advisors will have infrastructure (staff, systems, procedures, etc). set up to support the promises that were made to their clients (Servicing). They aren’t just spending all their commissions on expensive cars and expensive memberships.
Seek advisors that look to understand your unique estate planning needs. Your vision for your family, your business and your community. They get to know your current structure and objectives before they bring recommendations to you. They can then work to build the right insurance strategy for you.
As always, make sure you are a financial warrior, or that you have one on your side of the table. A trusted advisor works for you, is knowledgeable and experienced and can help ensure other advisors are working together and in pursuit of your best interests and not just their own.
Experience Financial – Coaching & Consulting Inc. is an Advice-Only Financial Planning business working with families and family businesses on estate, succession and transition planning. No AI was accessed, utilized or harmed in the writing or editing of this article.