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Building Walls Around Wealth With TransACE Survivor 2008

2. . This material was not intended or written to be used, and cannot be used, to avoid penalties imposed under the Internal Revenue Code. This material was written to support the promotion or marketing of the products, services, and/or concepts addressed in this material. Anyone to whom this mate

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Building Walls Around Wealth With TransACE Survivor 2008

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    1. Building Walls Around Wealth With TransACE Survivor® 2008 John Oliver, CLU, ChFC Vice President, Field Development

    2. 2 This material was not intended or written to be used, and cannot be used, to avoid penalties imposed under the Internal Revenue Code. This material was written to support the promotion or marketing of the products, services, and/or concepts addressed in this material. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely solely on their own independent advisors regarding their particular situation and the concepts presented here.

    3. 3 How Is Wealth Lost from Generation to Generation? Transfer taxes Divorce Creditors Beneficiaries’ lack of asset management skills Overspending Substance abuse

    4. 4 Influencing the Behavior of Beneficiaries Wealthy parents have two major concerns: Children are not going to live as well as they do Wealth that parents leave their children is going to spoil them How do you bridge gap between these two conflicting interests? Answer: Dynasty Trust

    5. 5 Considerations: Gifting to the Trust

    6. 6 Rudy & Randi Rate

    7. 7 Asset Diversification

    8. 8 TransACE Survivor® 2008: Internal Rate of Return

    9. 9 TransACE Survivor® 2008: Internal Rate of Return

    10. 10 Benefits of a Dynasty Trust Effective way to transfer significant assets to successive generations of beneficiaries Provides creditor protection Divorce Irresponsible spending Continuity of asset management May contain incentives for beneficiaries

    11. 11 Why Self-Finance Insurance Premiums? Arrangement could reduce potential gift taxes Uncomfortable leveraging funds from third party Do not want to turn over financial data to bank Do not want to incur debt Assets do not qualify as premium financing collateral The self-financing premium strategy is primarily for policies with sizable premiums that are owned by an irrevocable life insurance trust (ILIT). Life insurance is an important part of any high-net-worth individual’s financial picture. And while some clients choose to leverage their assets to purchase life insurance by utilizing premium financing, others would rather not borrow from a third-party lender to finance a life insurance policy. The reasons are as varied as the individuals: some clients are uncomfortable leveraging funds from a third party; they do not want to turn over financial data to a bank; they do not want to incur debt; and/or they have certain types of assets that do not qualify for premium financing collateral purposes. For clients needing a large amount of life insurance requiring sizable premiums, the self-financing premium strategy may have appeal.The self-financing premium strategy is primarily for policies with sizable premiums that are owned by an irrevocable life insurance trust (ILIT). Life insurance is an important part of any high-net-worth individual’s financial picture. And while some clients choose to leverage their assets to purchase life insurance by utilizing premium financing, others would rather not borrow from a third-party lender to finance a life insurance policy. The reasons are as varied as the individuals: some clients are uncomfortable leveraging funds from a third party; they do not want to turn over financial data to a bank; they do not want to incur debt; and/or they have certain types of assets that do not qualify for premium financing collateral purposes. For clients needing a large amount of life insurance requiring sizable premiums, the self-financing premium strategy may have appeal.

    12. 12 How it Works Client acts as 3 parties: Lendor Grantor Insured In two steps: Client lends funds to a new or existing trust Trust purchases life insurance policy

    13. 13 The trust pays loan interest to client/grantor From trust income and/or From grantor gifts Payment of Loan Interest The trust will likely need to pay loan interest annually on the funds borrowed from the client. This payment can either be made by income earned on trust-owned assets and/or with gifts from the grantor to the trust. As will be discussed later, the trust may need to own additional assets besides the life insurance policy in order to maintain legitimacy concerning the loan transaction. It is income from these assets that could be a possible source for paying loan interest.The trust will likely need to pay loan interest annually on the funds borrowed from the client. This payment can either be made by income earned on trust-owned assets and/or with gifts from the grantor to the trust. As will be discussed later, the trust may need to own additional assets besides the life insurance policy in order to maintain legitimacy concerning the loan transaction. It is income from these assets that could be a possible source for paying loan interest.

    14. 14 Self-Financing Premium Strategy Example The chart summarizes the steps that are typically taken in the Self-Financing Premium Strategy. The client lends funds to his/her irrevocable life insurance trust (ILIT), and in exchange receives an interest-bearing note from the ILIT. The ILIT then uses the borrowed funds to purchase a life insurance policy, insuring the client’s life. The ILIT will pay loan interest either with income earned by trust-owned assets and/or with gifts from the client/grantor to the trust. In addition to gifts to pay loan interest, the client may also need to make additional gifts to the ILIT to “seed” it. The act of “seeding” the ILIT is a possible way of establishing the ILIT’s economic substance. Although the client, in addition to making gifts to the trust for loan interest, may have to make gifts of “seed” assets, the total amount of gifts made by the client may still be less than if the client made gifts of cash equal to the entire premium amount of the policy to the trust. This could result in gift tax savings to the client (similar to the gift tax savings obtained from commercial premium financing), and is one of the advantages of the Self-Financing Premium Strategy.The chart summarizes the steps that are typically taken in the Self-Financing Premium Strategy. The client lends funds to his/her irrevocable life insurance trust (ILIT), and in exchange receives an interest-bearing note from the ILIT. The ILIT then uses the borrowed funds to purchase a life insurance policy, insuring the client’s life. The ILIT will pay loan interest either with income earned by trust-owned assets and/or with gifts from the client/grantor to the trust. In addition to gifts to pay loan interest, the client may also need to make additional gifts to the ILIT to “seed” it. The act of “seeding” the ILIT is a possible way of establishing the ILIT’s economic substance. Although the client, in addition to making gifts to the trust for loan interest, may have to make gifts of “seed” assets, the total amount of gifts made by the client may still be less than if the client made gifts of cash equal to the entire premium amount of the policy to the trust. This could result in gift tax savings to the client (similar to the gift tax savings obtained from commercial premium financing), and is one of the advantages of the Self-Financing Premium Strategy.

    15. 15 Trust Requirements Must have adequate economic substance; otherwise, may run risk of being declared nonexistent for estate tax exclusion Trust seeding vs. loan guarantee by trust beneficiaries As part of this technique, it is important that the trust substantiate that it has adequate economic substance of its own. Otherwise, the trust may run the risk of being declared “nonexistent” by the Internal Revenue Service, with the potential result that all trust assets will be included in the grantor’s estate. Consequently, the trust should have its own funds to demonstrate that it has the ability to pay interest to the grantor. Many commentators believe that the trust should have its own funds (outside of the funds which are lent to the trust) to demonstrate that it has the financial ability to borrow from and pay interest to the grantor. Not all commentators agree that the trust needs to have funds in order to demonstrate financial ability to borrow funds. It has been suggested that, rather than seeding the trust, the trust beneficiaries could guarantee the loan for the trust, thus requiring them to fulfill the terms of the loan should the trust ever fail in paying the required loan interest or principal. This approach would appear to be limited to use by beneficiaries with adequate economic resources to fulfill this obligation in the event of default. It is unclear if such a guarantee would be a gift by the beneficiaries or give economic substance to the trust. As part of this technique, it is important that the trust substantiate that it has adequate economic substance of its own. Otherwise, the trust may run the risk of being declared “nonexistent” by the Internal Revenue Service, with the potential result that all trust assets will be included in the grantor’s estate. Consequently, the trust should have its own funds to demonstrate that it has the ability to pay interest to the grantor. Many commentators believe that the trust should have its own funds (outside of the funds which are lent to the trust) to demonstrate that it has the financial ability to borrow from and pay interest to the grantor. Not all commentators agree that the trust needs to have funds in order to demonstrate financial ability to borrow funds. It has been suggested that, rather than seeding the trust, the trust beneficiaries could guarantee the loan for the trust, thus requiring them to fulfill the terms of the loan should the trust ever fail in paying the required loan interest or principal. This approach would appear to be limited to use by beneficiaries with adequate economic resources to fulfill this obligation in the event of default. It is unclear if such a guarantee would be a gift by the beneficiaries or give economic substance to the trust.

    16. 16 “Seeding” the Trust Percentage of loan may demonstrate financial independence Initial gift may be 10% to 20% of loan The earlier, the better Client should consult financial advisors Commentators have speculated that “seeding” the trust with an acceptable percentage of the loan may serve to demonstrate a trust’s financial independence. They have also opined that an acceptable initial gift to the trust may be 10% to 20% of the loan. Generally, the earlier the grantor can “seed” the trust prior to purchasing the life insurance and receiving an interest payment from the trust, the better. However, since there have been no official rulings or guidelines issued regarding a trust’s economic independence, it is important that the client, along with his or her financial professionals, assess his or her risk profile and make decisions regarding the self-financing technique and the “seeding” of the trust accordingly.Commentators have speculated that “seeding” the trust with an acceptable percentage of the loan may serve to demonstrate a trust’s financial independence. They have also opined that an acceptable initial gift to the trust may be 10% to 20% of the loan. Generally, the earlier the grantor can “seed” the trust prior to purchasing the life insurance and receiving an interest payment from the trust, the better. However, since there have been no official rulings or guidelines issued regarding a trust’s economic independence, it is important that the client, along with his or her financial professionals, assess his or her risk profile and make decisions regarding the self-financing technique and the “seeding” of the trust accordingly.

    17. 17 Structuring the Trust Three reasons to consider an “intentionally defective grantor trust” Income earned by invested seed money taxed to grantor Trust does not deplete own funds to pay income taxes Helps ensure trust property stays out of estate As with all planning strategies utilizing trusts, the structure of a trust has tax consequences. Clients wishing to pursue the Self-Financing Premium Strategy may want to consider creating an “intentionally defective grantor trust.” Under a defective trust design, the income earned by the trust is taxed to the grantor and not the trust. This aspect benefits trust beneficiaries since trust assets are not depleted to pay the tax liabilities created by taxable income. This, in essence, is equivalent to providing additional gifts to the trust without using any gift tax exemptions or paying a gift tax. For estate tax purposes, the trust is considered an irrevocable trust and the trust’s assets should not be considered part of the grantor’s estate.As with all planning strategies utilizing trusts, the structure of a trust has tax consequences. Clients wishing to pursue the Self-Financing Premium Strategy may want to consider creating an “intentionally defective grantor trust.” Under a defective trust design, the income earned by the trust is taxed to the grantor and not the trust. This aspect benefits trust beneficiaries since trust assets are not depleted to pay the tax liabilities created by taxable income. This, in essence, is equivalent to providing additional gifts to the trust without using any gift tax exemptions or paying a gift tax. For estate tax purposes, the trust is considered an irrevocable trust and the trust’s assets should not be considered part of the grantor’s estate.

    18. 18 Structuring the Loan Note Four important considerations Type of note affects interest rate Demand note vs. term note Payment of interest Security interest in life insurance policy To ensure that the loan is not viewed as a sham, and to avoid the consequences if the interest rate on the note is deemed understated or “below market,” the structure of the loan is extremely important. Demand vs. Term Note A self-financing premium arrangement will possibly be deemed a split-dollar plan. Therefore, under the split-dollar regulation, the appropriate interest rate to charge on the note will depend on whether the note is a demand or a term note. A demand note is a note that must be paid in full at any time on the demand of the lender, while a term note normally must be paid in full after a certain term (for example, 10 years). If the note is a demand note, the minimum interest rate that must be charged is based on a blended annual federal rate and will change annually based on the market, while the appropriate Applicable Federal Rate (AFR) to be used for the term note is based on the number of years of the note and is fixed for the entire note term. Security Interest in the Life Insurance Policy In most commercial premium financing arrangements, the policy’s cash value is assigned to the lender through an assignment placed with the insurance carrier. This could also be done in a self-financing premium arrangement, but care would need to be taken to draft the assignment and the corresponding loan document so that the grantor has no direct access to the policy or its cash value resulting in incidence of ownership over the policy. The assignment generally would only give the grantor the right to access cash value if the policy is surrendered or if death of the insured occurs while the loan is still outstanding.To ensure that the loan is not viewed as a sham, and to avoid the consequences if the interest rate on the note is deemed understated or “below market,” the structure of the loan is extremely important. Demand vs. Term Note A self-financing premium arrangement will possibly be deemed a split-dollar plan. Therefore, under the split-dollar regulation, the appropriate interest rate to charge on the note will depend on whether the note is a demand or a term note. A demand note is a note that must be paid in full at any time on the demand of the lender, while a term note normally must be paid in full after a certain term (for example, 10 years). If the note is a demand note, the minimum interest rate that must be charged is based on a blended annual federal rate and will change annually based on the market, while the appropriate Applicable Federal Rate (AFR) to be used for the term note is based on the number of years of the note and is fixed for the entire note term. Security Interest in the Life Insurance Policy In most commercial premium financing arrangements, the policy’s cash value is assigned to the lender through an assignment placed with the insurance carrier. This could also be done in a self-financing premium arrangement, but care would need to be taken to draft the assignment and the corresponding loan document so that the grantor has no direct access to the policy or its cash value resulting in incidence of ownership over the policy. The assignment generally would only give the grantor the right to access cash value if the policy is surrendered or if death of the insured occurs while the loan is still outstanding.

    19. 19 Historical Applicable Federal Rates (AFR)1 2007 4.92% May ’07 4.85% 4.62% 4.90% 2006 4.71% May ’06 4.85% 4.84% 5.00% 2005 3.11% May ’05 3.54% 4.28% 4.83% 2004 1.98% May ’04 1.50% 3.16% 4.65% 2003 1.52% May ’03 1.53% 3.17% 4.79% 2002 2.78% May ’02 3.21% 4.99% 5.85% 2001 4.98% May ’01 4.25% 4.77% 5.43% 2000 6.24% May ’00 6.42% 6.40% 6.20% 10-yr. avg. 4.08% 1 Rates reflect historical AFR and are not indicative of future results. 2 Imputed interest rate is based on the blended AFR published every July by the IRS. This slide shows a table of the recent history of selected AFR rates back to 2000 for general comparisons with interest rates that apply to third-party premium financing situations. Note that these rates reflect the recent low interest rate environment and, like market rates in general, continue to increase over the next few years. Note also that the AFR will vary by the month the loan is made and by the loan’s compounding period.This slide shows a table of the recent history of selected AFR rates back to 2000 for general comparisons with interest rates that apply to third-party premium financing situations. Note that these rates reflect the recent low interest rate environment and, like market rates in general, continue to increase over the next few years. Note also that the AFR will vary by the month the loan is made and by the loan’s compounding period.

    20. 20 Rudy & Randi Rate

    21. 21 Establish intentionally defective grantor trust Lawyer carefully drafts loan documents between Rudy, Randi and the trust Interest paid to Rudy & Randi by trust comparable to interest paid in premium-financing situation Rudy & Randi Rate Buck, Betty, their lawyer, and financial advisors set up an intentionally defective grantor trust as the first step. Their lawyer then carefully drafts the loan documents between Buck and Betty and the trust, noting the terms and conditions of the loan, including reporting and repayment requirements. The interest paid to Buck and Betty by the trust is comparable to the interest that would be paid to a third-party lender in a premium-financing situation.Buck, Betty, their lawyer, and financial advisors set up an intentionally defective grantor trust as the first step. Their lawyer then carefully drafts the loan documents between Buck and Betty and the trust, noting the terms and conditions of the loan, including reporting and repayment requirements. The interest paid to Buck and Betty by the trust is comparable to the interest that would be paid to a third-party lender in a premium-financing situation.

    22. 22 Gift $25,000 (10% of $249,134 loan to trust for life insurance premiums) to trust Establish trust’s economic substance by gifting “seed” money Trust invests “seed” money with income from this investment being used to help make annual interest payments Rudy & Randi, as grantors, pay income tax on income earned from trust’s investments Trust purchases $10 million TransACE Survivor® 2008 policy Rudy & Randi Rate Buck and Betty then use part of their lifetime exemption to gift $21,200 (10% of the $212,000 that they loan to the trust for life insurance premiums) to the trust to establish its economic substance. The trust will invest the “seed” money to generate income that will be used to help make annual interest payments to Buck and Betty in their role as lenders. The trust then uses the funds received as a loan from Buck and Betty to purchase a TransACE Survivor GL universal life insurance policy. Buck and Betty may need to make additional gifts of cash to help the trust with the interest payments as it’s likely the trust won’t earn as much interest as it must pay to Buck and Betty. Each year, Buck and Betty make loans to the trust to pay the premium and may make additional gifts as necessary to ensure that the trust has sufficient funds to continue to make loan interest payments. Since they are using an intentionally defective grantor trust for this strategy, Buck and Betty, as grantors, will pay the income tax on the income earned from the trust’s investments, but should not pay tax on the interest paid to them by the trust. Buck and Betty then use part of their lifetime exemption to gift $21,200 (10% of the $212,000 that they loan to the trust for life insurance premiums) to the trust to establish its economic substance. The trust will invest the “seed” money to generate income that will be used to help make annual interest payments to Buck and Betty in their role as lenders. The trust then uses the funds received as a loan from Buck and Betty to purchase a TransACE Survivor GL universal life insurance policy. Buck and Betty may need to make additional gifts of cash to help the trust with the interest payments as it’s likely the trust won’t earn as much interest as it must pay to Buck and Betty. Each year, Buck and Betty make loans to the trust to pay the premium and may make additional gifts as necessary to ensure that the trust has sufficient funds to continue to make loan interest payments. Since they are using an intentionally defective grantor trust for this strategy, Buck and Betty, as grantors, will pay the income tax on the income earned from the trust’s investments, but should not pay tax on the interest paid to them by the trust.

    23. 23 TransACE Survivor 2008

    24. 24 Achieve their estate planning goals Bypass often stringent financial and administrative requirements of third-party lender Rudy & Randi free to purchase coverage appropriate for their financial goals No strict third-party financial underwriting No collateral required Rudy & Randi Rate By self-financing the premium, Buck and Betty are able to achieve their estate planning goals while bypassing the often stringent financial and administrative requirements of a third-party lender. Additionally, Buck and Betty will not be required to pledge collateral to qualify for the loan. It’s important to note that any unpaid loan balance existing at the death of the insureds would be includible in their gross estate. Of course, with proper structuring of the trust and loan arrangement, the life insurance proceeds would be excludable and could provide the estate with liquidity.By self-financing the premium, Buck and Betty are able to achieve their estate planning goals while bypassing the often stringent financial and administrative requirements of a third-party lender. Additionally, Buck and Betty will not be required to pledge collateral to qualify for the loan. It’s important to note that any unpaid loan balance existing at the death of the insureds would be includible in their gross estate. Of course, with proper structuring of the trust and loan arrangement, the life insurance proceeds would be excludable and could provide the estate with liquidity.

    25. 25 Who Can Benefit from the Self-Financing Premium Strategy? Clients who: Have substantial wealth Want to keep their finances private Want to remain debt-free Want flexibility Appreciate the benefits of premium financing Want potential gift tax savings The Self-Financing Premium Strategy can be an attractive option for clients who have substantial wealth and appreciate the benefits premium financing provides, without having to undergo the rigorous financial scrutiny or incur the debt involved with a third-party lender.The Self-Financing Premium Strategy can be an attractive option for clients who have substantial wealth and appreciate the benefits premium financing provides, without having to undergo the rigorous financial scrutiny or incur the debt involved with a third-party lender.

    26. 26 Exit Strategies Grantor Retained Annuity Trusts Commercial Financing

    27. 27 TransWare: Family Trust Illustration

    28. 28 http://www.transamerica.com/legacy

    29. 29 http://www.transamerica.com/legacy

    30. 30 Tools & Resources

    31. 31 Transamerica Insurance & Investment Group (“Transamerica”) and its representatives do not give ERISA, tax, or legal advice. This presentation is provided for informational purposes only and should not be construed as ERISA, tax, or legal advice. Clients and other interested parties must be urged to rely solely upon their own independent advisors regarding their particular situation and the concepts presented here. Discussions of the various planning strategies and issues are based on our understanding of the applicable federal income, gift, and estate tax laws in effect at the time of this presentation. However, tax laws are subject to interpretation and change, and there is no guarantee that the relevant tax authorities will accept Transamerica’s interpretations. Additionally, this material does not take into consideration the general tax and ERISA provisions applicable to qualified retirement plans or the applicable state laws of clients and prospects. Although care is taken in preparing this material and presenting it accurately, Transamerica disclaims any express or implied warranty as to the accuracy of any material contained herein and any liability with respect to it. This information is current as of May 2007. Transamerica Insurance & Investment Group is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Suite 700, Nashville, TN 37219-2417. Web site: www.nasba.org. In the state of New York, Transamerica Occidental Life Insurance Company is an approved provider of continuing education courses (Provider Organization Approval Number NYPO-100366).

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