Paying for Large Insurance Premiums Daniel Capobianco, J.D. and Ron Ware, J.D. June 17, 2009 1.

Paying for Large Insurance PremiumsPaying for Large Insurance Premiums

Daniel Capobianco, J.D.

and Ron Ware, J.D.

June 17, 2009

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Planning for the high net worth client often requires the use of life insurance as an important component of the plan

Today’s TopicToday’s Topic

© Law Offices of Daniel B. Capobianco

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Issues to be AddressedIssues to be Addressed

What if annual premiums exceed available Crummey Exclusions

What if insured (grantor) has used up $1,000,000 lifetime exclusion

How to “roll out” of a premium finance plan (or private split dollar plan)

What if the insured “can’t afford” the annual premium– Usually this means “I don’t see the value of

buying insurance”


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Universal LifeNo Lapse GuaranteeWhole LifeVariable Universal LifeGuaranteed VUL

Product Design of Life InsuranceProduct Design of Life Insurance


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Policy ConsiderationsPolicy Considerations

Rating of Carrier (insolvency risk) Use of Multiple Carriers to spread risk Use of Multiple Policies


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Methods of Premium PaymentMethods of Premium Payment

Insured (grantor) gives money to ILIT and the ILIT makes premium payments– Crummey Gifts

Insured’s company pays premium directly to the insurance company– Split Dollar

Third party loans funds to ILIT and the ILIT makes premium payments– Premium Financing


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Split Dollar RulesSplit Dollar Rules

Rules were substantially changed, but the basics remain the same.

There are two regimes – The “Economic Benefit” and the “Loan”

They are mutually exclusive


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Split Dollar RulesSplit Dollar Rules ECONOMIC BENEFIT -- the life insurance policy

is actually owned by the grantor-insured– Policy equity belongs to the insured (and therefore is in

his or her estate)– Tax is imposed on the annual term cost (formerly known

as “PS 58 cost”) as dictated by the IRS (Table Rate) or the insurer’s alternative term rates. In the case of second-to-die, these amounts must be extrapolated

– The Regulations permit the policy to be owned by an irrevocable life insurance trust (“ILIT”) and collaterally assign a security interest in the policy to the grantor-insured, as long as the ILIT does not retain any equity in the policy


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Split Dollar RulesSplit Dollar Rules

LOAN REGIME-- the life insurance policy is owned by the ILIT– Policy equity belongs to the ILIT– Tax is imposed on the interest on the

premium loans– The interest is measured by the AFR

rather than the Table Rate– Loan can be demand, short, mid- or

long-term


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““Private Split Dollar”Private Split Dollar”

When Premiums are likely to exceed gift tax exclusion

Premiums are Grantor loansCarry IRS interestCan be given to spouse (marital

deduction)Can be funded by company


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Premium FinancingPremium Financing

An arrangement in which the Irrevocable Trust borrows money from a third-party lender to pay premiums

The policy is collaterally assigned to the lender

Interest due on the cumulative premium loan can either be paid currently or funded from the policy (i.e., accrued)


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Premium Financing (Exit Strategy)Premium Financing (Exit Strategy)

The loan is repaid and the collateral assignment is released

Loan can be repaid on death of the insured out of the death benefits payable

Loan can be repaid during life from the CSV of the policy

Loan can be repaid from collateralized assets (may be serious gift tax implications)

Combination of the above


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Components of the SolutionComponents of the Solution

Large cases will not fit neatly into any one strategy and accordingly two or more strategies are often integrated together to achieve the overall goal

As the prospective client goes through the planning process, the value of life insurance becomes obvious and the “cost” of such insurance is viewed as an investment in the family legacy


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Dynasty TrustDynasty Trust


It is an irrevocable trust – e.g., an ILIT It is designed to span more than one

generation– Does not terminate until the maximum period

allowed under the law (e.g., 90 years or more in Massachusetts)

– Value of trust assets not included in the estates of children or grandchildren

Takes maximum advantage of the $3,500,000 GSTT exemption

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Dynasty TrustDynasty Trust


Appreciation of assets will be estate tax free

Provides a layer of asset protection from the beneficiaries’ creditors

Assets appreciate outside of the transfer tax system

Can be the remainder beneficiary of a GRAT

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Limited Partnership with family members as limited partners and senior members are the general partners

Securities and real estate are typical assets of the FLP

Donor makes gifts of limited partnership interests to next generation

• Annual exclusion gifts

• Lifetime exemption ($1,000,000)

• Gift FLP interests to trusts rather than to children

outright

Family Limited Partnership (FLP)Family Limited Partnership (FLP)


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– Valuation discounts are often taken:• Lack of marketability• Lack of management control (minority interest)

– Retention of general partnership interest

allows senior generation to retain control

while transferring future appreciation out

of taxable estate.

FLP BasicsFLP Basics


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It is an irrevocable trust – e.g., an ILIT Contains specific language intended to

“violate” income tax rules, yet NOT violate the estate tax rules– Grantor is taxed on the income of the trust– Value of trust assets is not included in grantor’s

estate This is both a “freezing” technique And an “asset burn” technique

Intentionally Defective Grantor TrustIntentionally Defective Grantor Trust


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Grantor cannot be a beneficiary or trustee

Spouse & children are beneficiariesRequires careful drafting



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Sale to trust– Business owner receives cash and installment note for

balance of the selling price– No capital gain on sale

Interest received on note is not taxable Installment obligation is paid through income

received by trust Installment Note

– Self-amortizing– Demand note– Interest-only balloon note



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Grantor Retained Annuity TrustGrantor Retained Annuity Trust

A GRAT is a split interest trust in which a grantor retains the lead annuity interest, while transferring the remainder interest to non-charitable beneficiaries (e.g., children)

A GRAT is used to transfer substantial assets out of the estate at zero gift tax cost and without using any applicable exclusion amount


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Grantor Retained Annuity TrustGrantor Retained Annuity Trust

Whenever the total return on the trust assets exceeds the applicable IRC §7520 rate, property will pass tax free to the remainder beneficiaries

AFR as of June 2009 is 2.8% An effective way to GSTT-proof a dynasty

trust without incurring additional gift tax ($3,500,000 GST exemption, but only a $1,000,000 lifetime gift exemption)

GST allocation made at GRAT termination


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GRAT BasicsGRAT Basics

The amount of the taxable gift is the value of the property transferred to the trust minus the present value of the retained annuity interest.

By setting the present value of the annuity stream equal to the full value of the property initially transferred to the GRAT, the amount of the taxable gift is reduced to zero (a “zeroed-out” GRAT)


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At the end of the GRAT term, any property remaining in the trust will pass to the remainder beneficiaries with no further tax consequences

If the total return the trust assets actually produce is equal to or less than the rate assumed by the IRS (IRC §7520 rate) there will be nothing left in the trust to pass to the remainder beneficiaries at the end of the GRAT term

If the actual total return substantially exceeds the IRC §7520 rate, however, very large amounts of property will be in the trust to pass to the remainder beneficiaries tax free


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Calculation of the annuity & gift– Term of the GRAT– AFR for the month of GRAT formation– FMV of asset transferred into the GRAT

Where the FMV of the asset can be legitimately discounted (e.g., FLP interest or closely held stock) the tax efficiency of the GRAT is substantially magnified


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The grantor is responsible for the income tax on the GRAT’s taxable income

The grantor may be reimbursed by the GRAT for any income tax paid on income in excess of the annuity amount

If the grantor is not reimbursed by the GRAT, then the taxes paid by the grantor are in effect an additional non-taxable “gift” to the remainder beneficiaries


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In the event earnings of the GRAT are not enough to satisfy the required annuity amount, the GRAT could also distribute GRAT property back to the grantor with no income tax effect

Although earnings are more desirable, the distribution of GRAT assets continues to freeze growth at the IRC §7520 rate for the property remaining within the GRAT.

If GRAT property is paid out in-kind, the grantor could “Re-GRAT” the in-kind distribution to a new GRAT


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GRAT ExampleGRAT Example

$3,000,000 FMV asset transferred to GRAT. AFR is 2.8%. Term = 10 years.

Annual annuity = $348,112


Beginning Balance

Growth @ 3% Payment

Ending Balance

1 3,000,000$ 90,000$ (348,112)$ 2,741,888$ 2 2,741,888$ 82,257$ (348,112)$ 2,476,033$ 3 2,476,033$ 74,281$ (348,112)$ 2,202,202$ 4 2,202,202$ 66,066$ (348,112)$ 1,920,156$ 5 1,920,156$ 57,605$ (348,112)$ 1,629,648$ 6 1,629,648$ 48,889$ (348,112)$ 1,330,426$ 7 1,330,426$ 39,913$ (348,112)$ 1,022,227$ 8 1,022,227$ 30,667$ (348,112)$ 704,781$ 9 704,781$ 21,143$ (348,112)$ 377,813$ 10 377,813$ 11,334$ (348,112)$ 41,035$ 28


What if rate of return were 6%


Beginning Balance

Growth @ 6% Payment

Ending Balance

1 3,000,000$ 180,000$ (348,112)$ 2,831,888$ 2 2,831,888$ 169,913$ (348,112)$ 2,653,689$ 3 2,653,689$ 159,221$ (348,112)$ 2,464,799$ 4 2,464,799$ 147,888$ (348,112)$ 2,264,575$ 5 2,264,575$ 135,874$ (348,112)$ 2,052,337$ 6 2,052,337$ 123,140$ (348,112)$ 1,827,365$ 7 1,827,365$ 109,642$ (348,112)$ 1,588,895$ 8 1,588,895$ 95,334$ (348,112)$ 1,336,117$ 9 1,336,117$ 80,167$ (348,112)$ 1,068,172$ 10 1,068,172$ 64,090$ (348,112)$ 784,150$

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If the asset could be discounted 33% -- even if there were little or no rate of return


Beginning Balance

Growth @ 3% Payment

Ending Balance

1 3,000,000$ 90,000$ (232,075)$ 2,857,925$ 2 2,857,925$ 85,738$ (232,075)$ 2,711,588$ 3 2,711,588$ 81,348$ (232,075)$ 2,560,860$ 4 2,560,860$ 76,826$ (232,075)$ 2,405,611$ 5 2,405,611$ 72,168$ (232,075)$ 2,245,705$ 6 2,245,705$ 67,371$ (232,075)$ 2,081,001$ 7 2,081,001$ 62,430$ (232,075)$ 1,911,356$ 8 1,911,356$ 57,341$ (232,075)$ 1,736,621$ 9 1,736,621$ 52,099$ (232,075)$ 1,556,645$ 10 1,556,645$ 46,699$ (232,075)$ 1,371,269$

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What if rate of return were 6%


Beginning Balance

Growth @ 6% Payment

Ending Balance

1 3,000,000$ 180,000$ (232,075)$ 2,947,925$ 2 2,947,925$ 176,876$ (232,075)$ 2,892,726$ 3 2,892,726$ 173,564$ (232,075)$ 2,834,214$ 4 2,834,214$ 170,053$ (232,075)$ 2,772,192$ 5 2,772,192$ 166,332$ (232,075)$ 2,706,448$ 6 2,706,448$ 162,387$ (232,075)$ 2,636,760$ 7 2,636,760$ 158,206$ (232,075)$ 2,562,891$ 8 2,562,891$ 153,773$ (232,075)$ 2,484,589$ 9 2,484,589$ 149,075$ (232,075)$ 2,401,590$ 10 2,401,590$ 144,095$ (232,075)$ 2,313,610$

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ILIT Premiums are financed

– Traditional split dollar (paid by company)– Private (paid by the insured)– Third Party Financing (financial institution)– both split dollar & §7872 regulations apply

Create a GRAT GRAT rolls out into ILIT at termination Proceeds from GRAT used to pay off split

dollar loan

GRAT – Split Dollar ComboGRAT – Split Dollar Combo


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ExampleExample

Age 55 -- $2,000,000 whole life; premium $100,000 for 10 years. Estate is taxable. Insured has used up his $1 million gift tax exemption. How do we pay the premium?

Insured contributes $100,000 per year to ILIT Annual contribution treated as split dollar loan Insured Forms FLP with $3 million of assets. Discounted value is $2 million

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ExampleExample

No growth expected - but 3% earned each year

Contribute FLP to a 10 year “Zero-GRAT” GRAT calculations are based on the discounted

value After 10 year term, $1.3 million is transferred to

ILIT (allocate $1.3 million GST exemption at this time)– Free of gift taxes

Money is then used to repay the split dollar loan plus interest (almost $1.23 million)

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Family Trust$2,500,000

($3,500,000 less $1,000,000 gifted to ILIT)

Family Trust$2,500,000

($3,500,000 less $1,000,000 gifted to ILIT)

QTIP Trust (for Cynthia)Minimum amount required

to reduce estate to $0

QTIP Trust (for Cynthia)Minimum amount required

to reduce estate to $0

Life Insurance Trust

Insert additional special provisions for IDGT to

permit ownership of additional assets (initially

funded with $1,000,000)

Life Insurance Trust

Insert additional special provisions for IDGT to

permit ownership of additional assets (initially

funded with $1,000,000) Sam Smith Revocable Trust

Sam Smith Revocable Trust

Family Dynasty TrustMary, Mike and Lisa & their

children/descendantsTrust will be divided into 3 unique trusts

for each childEach child can be a Co-Trustee

Family Dynasty TrustMary, Mike and Lisa & their

children/descendantsTrust will be divided into 3 unique trusts

for each childEach child can be a Co-Trustee


Integrated Estate Plan Integrated Estate Plan with Multiple Tax Strategieswith Multiple Tax Strategies

Sam Smith GRAT(on termination flows to ILIT if

Sam alive / to RLT if Sam dies)

Sam Smith GRAT(on termination flows to ILIT if

Sam alive / to RLT if Sam dies)

Sam Smith FLPHolds stock, real estate, etc.

Sam Smith FLPHolds stock, real estate, etc.

BY SALE AND/OR GIFT directly to the ILIT or re-route

through GRAT

SCIN and /or interest-only Promissory Note

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Gift stock to GRAT for specified term of years (5, 10, 15).

Beneficiary is an Irrevocable Trust f/b/o Wife, children &

descendants

At termination of GRAT, cash,

stock and/or FLP interest is

distributed to Trust with no

further gift tax costs

Sam Smith FLP and/or S Corporation

Sam Smith FLP and/or S Corporation

Sam Smith makes gift of FLP interests and/or S

Corp. stock (at a discount)

Sam Smith makes gift of FLP interests and/or S

Corp. stock (at a discount)

ILIT – IDGT – Dynastyfor benefit of Wife,

children & descendants of Sam Smith

ILIT – IDGT – Dynastyfor benefit of Wife,

children & descendants of Sam Smith

Any “excess” tax incurred by Sam Smith can be

reimbursed by GRAT

Cash distributions

based on ownership

transferred

GRAT pays annuity to Sam Smith based upon existing

IRS interest rate. Cash to make payment is received from Sam Smith

Companies

GRAT pays annuity to Sam Smith based upon existing

IRS interest rate. Cash to make payment is received from Sam Smith

Companies

GRAT to Transfer S Corp. and/or FLPGRAT to Transfer S Corp. and/or FLP


Cash received from

GRAT is used to “loan”

money to ILIT

pay

insurance

premiums

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Gift of $100,000 to Irrevocable Trust for children/grandchildren.

File gift tax return to allocate GST

Sale of Doe Sales Co common stock for

20-year term promissory note. Interest

payable at AFR of 3.88%

Sam Smith CompaniesSam Smith Companies

Sam Smith gift/sale of common stock

Sam Smith gift/sale of common stock

Sam Smith Family “Defective” Dynasty Trustfor benefit of children &

descendants of Sam Smith

Sam Smith Family “Defective” Dynasty Trustfor benefit of children &

descendants of Sam Smith

Interest paid annually to cover tax payments

Principal payable on demand (as needed)

Distributions

of cash

Based on the value of the stock sold ($2,000,000), and the monthly AFR (3.88% in June 2009), the annual interest

payment will be $77,600, which will be sufficient to pay income taxes on DSC earnings. This interest is not taxable to

Sam Smith and not deductible by the trust since the trust is a “grantor trust.” Alternatives are a private annuity for

life ($115,652 per year) or a SCIN over 20 years ($146,805 per year) or an interest-only SCIN ($86,991 per year).

Sam Smith’s income tax liability is the same before and after the transaction.

Trust can pay down promissory note “on demand” for additional cash flow to Sam Smith.

Sale to Defective Grantor TrustSale to Defective Grantor Trust

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Paying for Large Insurance Premiums Daniel Capobianco, J.D. and Ron Ware, J.D. June 17, 2009 1.

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Transcript of Paying for Large Insurance Premiums Daniel Capobianco, J.D. and Ron Ware, J.D. June 17, 2009 1.