Friday, December 12, 2014

Why would a billionaire need life insurance?

It is generally believed that life insurance is only for those who aren't wealthy. This is because people tend to think of life insurance as a way to cover the needs of a destitute widow and her children. But nothing could be further from the truth.
image of luxury car next to an executive jet.
A life insurance policy is a high-leverage financial instrument like no other. It also enjoys unique tax treatment privileges equal to no none. In a nutshell, there isn't a single financial product that can deliver the power of markets in a single laser-focused product. It can uniquely add liquidity at a time when illiquid assets turn your net-worth into no more than meaningless data noise.
Let me sound the warning bell for those running a successful business, those who are asset rich and those who are passing through the most productive time in their lives. By no means should you assume that there is no place for an insurance policy just because money seems to rain all around you. Last I checked, those who earn big also take on larger bets. And it is these bets that can drain liquidity at the worst moment.
There's a simple way to determine the absolute lowest amount of life insurance needed by an individual; including these asset rich billionaires.

In the video link above, CNBC discusses how even the mega-rich must have life insurance to cover the cash needed for the so called death taxes and for paying off all loans outstanding. Here is the formula in detail:

Min Coverage    =    All Debt    +    Possible Capital Gains    +    (0.45  x   Net-Worth)

The formula is simple. Total all your outstanding loans. They are going to get called after death. If you don't have the cash to pay for them now, how exactly will your family do it then?
Then add any capital gains from the sale of assets that may need to be liquidated. Here, a guesstimate would be preferred to doing nothing. In any case, this is not the biggest factor within the formula.
Finally, add 45% of all your net-worth. It will be owed to the IRS in the form of estate tax; which is often referred to as death tax. Ask yourself: would you be able to immediately write the IRS a check for 45% of all your assets? No? What a surprise.
While an argument can be made that, for many, estate taxes are irrelevant due to the aggregate value of assets falling below the $5.25 Million minimum for 2013, I would like to warn against quick conclusions; especially when a business is part of the estate transfer. Keep in mind that without mark-to-market price discovery it would be difficult to set a price for the business that the IRS would agree with. You may think that for tax reasons, your business is not very valuable as an inheritance. Surely soon after, the IRS will disagree. Would you like to pick a fight with the IRS about how much taxes they should collect based on such business valuation? Would you like to have your heirs take on the challenge without your help instead? With the cost of term life insurance being so low, the risk/reward ratio favors erring on the side of having to pay estate taxes.
contrast image of a family over a grassy field
Do note the caveat that no part of the resulting amount will be targeted to cover death related expenses, wealth transfer costs or replace any lost future earnings. This calculation will only serve to preserve the value of assets already held. That's it; just asset-loss elimination. As a result, I find that insuring for anything less would be irresponsible since the certainty of taxes and loan calls is always high.
picture of a female college graduate giving the thumbs upThis back-of-the-napkin calculation can simplify the decision of how much to protect as a minimum. Am I then suggesting that this is all the insurance you need? Of course NOT. You should also cover the value of all future productivity and hedge other business and family risks.
My goal here is humble. I want to simply show those who are successful today that their net-worth is not as much of a reliable hedge as they originally thought; that their asset wealth may not be enough to cover everything life brings. Look deeper into it. There are plenty of inexpensive solutions available.

Finally here is the caveat de rigueur:
This material is provided for educational purposes only and is not intended to be legal, financial or fiscal advise. Please seek the advise of a licensed professional in your state.

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