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Life insurance - part of the wealth-planning toolkit

Policyholders should make sure they understand the pros and cons of what they are buying, and be satisfied that it meets their planning needs

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A key benefit of insurance is that a payout is made to beneficiaries independent of the administration of the estate of the insured.

LIFE insurance products are often discussed as part of the design of a wealth and succession plan. There is a wide variety of life insurance products which are available, and there are often differing objectives which a policyholder will have in mind when deciding to take out a policy. 

In the most basic form, life insurance can be used to provide a benefit upon the passing or the total and permanent disability of the insured. Term life insurance can be an inexpensive option and provides coverage for a fixed period. This may be when a policyholder is starting out in life and wants coverage to ensure that a loved one will be able to maintain their lifestyle should an unfortunate accident occur. 

A term life policy may be contrasted with permanent life insurance which does not expire, provided a policyholder keeps up with their payment obligations. Universal life insurance is a form of permanent insurance and is the most flexible in terms of the profile of the premium payments, the death benefits and the cash surrender value. This  flexibility makes it potentially suitable to meet a range of wealth planning needs. 

Common uses 

In a typical structure, a universal life insurance policy may be acquired with a single upfront premium and issued over the life of a high net worth individual. The policy may be held through a trust or other succession vehicle. 

Upon the passing of the insured, a payout may be made to beneficiaries who may include the individual's family members or their own bespoke succession vehicles. Asset protection is achieved by the ownership of the policy via a trust, which may be preserved depending upon how the pay-out is directed. In some circumstances, it is possible for a policyholder to borrow against the cash surrender value of a policy, which adds further flexibility. 

A key benefit of insurance is that a pay-out is made to beneficiaries independent of the administration of the estate of the insured. Insurance can be used to provide liquidity to family members during this time, which can be protracted if  an estate is complicated or is contested.

Another use of insurance is to provide the liquidity which may be necessary to fund the payment of inheritance or estate tax. For example, the insured may be the owner of a substantial piece of residential property in the United Kingdom, which may otherwise have to be sold to pay the inheritance tax on its passing to the next generation. It is possible to obtain so-called ''second death'' policies that pay-out upon the passing of the surviving spouse. This can mirror the trigger point for the payment of inheritance tax which may be deferred due to a spousal exemption.

It is common that the assets supporting a universal life policy will be managed by the issuing insurance company or an asset management entity within that group. 

An insurance ''wrapper'' is the parlance used to describe a policy where a policyholder wishes to retain investment control or direct the composition of assets which are held by an insurance company. The circumstances where a high net worth individual may prefer one type of policy over the other are varied, and again illustrate the flexibility of insurance as a planning tool. 

Taxation issues

The taxation of insurance policies can be complicated and should be considered carefully. As a matter of general principle, the making of a payout to the beneficiary should generally not be treated as  income. The starting point is therefore that this benefit may not be subject to tax. 

It may also be possible to take the view that gains realised upon the cancellation of a policy with a surrender value should be non-taxable if the underlying policy is held as a capital asset. It is important to consider in detail these propositions as the tax characterisation will be highly fact-dependent. 

Insurance policies owned by policyholders who are residents in other jurisdictions should consider how these are treated for their own domestic tax purposes.  This includes whether tax is imposed on increases in the cash value or only if, and to the extent that, a policy is surrendered.

Insurance policies with a cash surrender value are generally treated as reportable for exchange of information purposes. This means that foreign policyholders should therefore plan on the basis that they will be queried on these policies by their domestic tax authorities. 

Life insurance is a well-established part of the wealth planning toolkit. It is a complicated and highly regulated financial product. Policyholders should always make sure they understand the pros and cons of what they are buying, and in particular, be satisfied that it meets their particular planning needs. W

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