Life Insurance Planning in a Low Interest Rate Environment
Asset Sale to a Defective Trust
Presented by:
0259913-00001-00 Ed. 04/2014 Exp. 10/07/2015
INSURANCE PRODUCTS: NOT INSURED BY FDIC OR ANY MAY LOSE NOT A DEPOSIT OF OR GUARANTEED FDIC BANK FEDERAL GOVERNMENT AGENCY VALUE BY ANY BANK OR ANY BANK AFFILIATE
Introduction
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Why are interest rates so low? What may cause rates to rise? How can low rates help with HNW planning?
Why low interest rates?
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Economy is in recovery mode
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Low interest rates => households, businesses spend, invest more
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More spending, investing => employment growth, rising GDP
The Recovery Cycle – At a Glance
New Demand for Goods, Services
Low Lending Low Fed Rates
Rates
Consumer, Investor Spending, Investment
Recovery
Employment, GDP
Confidence
Why could rates rise?
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The Good: Increased consumer, investor demand for credit vs. limited lending capital
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The Bad: Rising inflation
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The Ugly: U.S. debt ratings downgrade
Long-Term Growth – At a Glance
Rising Treasury Fed Relaxes Target Recovery: Sustained
Low Lending Low Fed Rates
Rates
Demand for Credit
Yields
Impact of Rising Treasury Yields
Treasury yields determine the AFR (borrowing) and § 7520 (discounting) rates for individual taxpayers
Treasury Yields
AFR
§ 7520
The Planning Benefits of Low Rates
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Lower interest rates make some wealth transfer strategies more efficient:
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Interest-only borrowing
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Sale of property where buyer has limited ability to pay
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Valuing a donor’s retained interest in property
Profile – Sale to Defective Trust
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Works in low rate environment because:
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Asset purchases financed at a low rate allows more asset income to be used for other purposes
For individual clients who…
Own large income producing assets Income is in excess of their current lifestyle need Are interested in leveraging the income and lifetime gift-tax exemption amounts for the benefit of heirs Who have a life insurance need where the premium is in excess of their willingness or capacity to gift Are able to pay income taxes on trust income using personal funds
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Hypothetical Case Study Example
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Married clients, both age 72, have a $10 million municipal bond portfolio paying 4.55% interest and $7 million dollars of other assets
– – –
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They do not need the bond income for living expenses The potential estate tax liability on the bonds is $4,000,000 Unspent Interest income will increase the size of the taxable estate
Clients understand the possible estate tax exposure and are looking forhelp
This hypothetical example is for illustrative purposes only. Actual results will vary.
How Does it Work? Step 1 – Create a Trust
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Step 1:
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Attorney creates “Intentionally Defective Trust (IDT)”
• –
The client will be the “grantor” of the trust
What is an “intentionally defective trust?”
The trust terms cause the grantor to remain responsible for tax on trust income even though the trust corpus is outside the grantor’s estate
All items of income and deduction are attributed back to grantor
Attorney Drafts IDT
IDT
How Does it Work? Step 2 - Sale to IDIT
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Step 2:
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Client “seeds” trust with $1,000,000 (gift)* Seed money is either/both a present interest gift (eligible for annual exclusion) or requires use of lifetime exemption
$1,000,000 Grantor
IDT IDT
*There may be federal gift tax consequences associated with the funding of an Irrevocable Life Insurance Trust.
How Does it Work? Step 3 - The LLC
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Step 3:
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Client transfers bond portfolio into an LLC (or partnership)
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The LLC creates flexibility because the underlying LLC interests can change hands multiple times by gift or sale without changing title to the bonds
Bond Portfolio Grantor
LLC LLC
How Does it Work? Step 3 - The LLC
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Step 4:
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Client sells LLC assets to the IDT
• •
No capital gains Income tax attributable to trust income is paid by the grantor
LLC
LLC IDT
Grantor
Promissory Note
How Does Step it Work? 5 – Introducing Life Insurance
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Steps 5 and 6:
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Cash flow from LLC assets pays note interest; excess for 9 years can be used to purchase life insurance
• • •
Bond portfolio yields $455,000 annually at 4.55% $184,000 note interest due annually to grantor at 1.84% (3/14 mid-term AFR) Remainder of $271,000 sufficient to purchase approximately $6,100,000 of guaranteed survivorship universal life insurance (9 Pay)
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Can pay off part of the debt if the client dies prematurely Can pay any federal estate taxes, prevent a forced sale of the assets upon death
Insurance Grantor
$184,000
IDTIDT
$271,000
Policy $6,100,000 Death Benefit
How Does it Work? Step 6 - Repayment
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Step 7:
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th At the end of the 9 year the note is due and the trustee pays off the note (in kind) with the LLC interests.
• • •
Repayment of principal is not a taxable event Client then owns the LLC, which owns the bond portfolio IDT has the paid-up guaranteed death benefit
IDT with
LLC IDT
Grantor
$6,100,000
$6,100,000 Insurance Policy (Paid Up)
Paid-Up Insurance Policy
The Big Picture
Grantor 4
3 Asset
Note
7 LLC
2
Sale of LLC in exchange for a $10MM promissory note
Nine $184k Interest $1,000,000 Seed Gift
Payments @ 1.84% AFR
Repayment of $10MM @ end of year 9
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IDT Economic Substance
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4 LLC
1
6 PruLifeSUL Protector with a guaranteedlifetime
Attorney Drafts IDT $6,121,959 Death Benefit
deathbenefit-- Maleand Female A72,PNT payments of $271,000
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Benefits
Results
Benefits:
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Clients effectively receive $184,000 of their bond interest for the next 9 years
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Excess cash flow was leveraged into life insurance to provide the estate with liquidity for the eventual estate taxes
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LLC with bond portfolio was returned to the client at the end of the 9 year period
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Any income taxes due on trust income were paid by the grantor, bestowing the trust with a significant economic benefit while making no actual gift
Getting Started Talking Points
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Do you know what some of the benefits low interest rates could have for your wealth transfer planning?
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Are you aware of the factors that may bring the economy out of this low interest rate environment?
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“We don’t want to give up control of our assets.”
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If you could find ways to minimize the loss of control over your assets, would you be interested in knowing more?
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Let me share an idea with you…
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Next Steps
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Individual meeting Clients Who May Benefit
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Identify prospects
High Net Worth ($10MM+) and family oriented
Are concerned about the impact of transfer taxes on their financial legacy
Have sufficient income from other sources, besides the assets used in the strategies
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Build and present case
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What’s In It For You? •
Enter the advanced planning club.
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Help clients to take action now.
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Preserve and/or increase assets under management (AUM).
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Support and Resources
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Summary
Why These Strategies, Why Now
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Taking advantage of low interest rates using the strategy described here could help to enhance wealth for heirs.
Why Life Insurance
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Life insurance is essential in managing the risks inherent in the strategy, and may also further enhance the amount of wealth going to heirs.
Getting Started
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Implementing the strategy using simple talking points and our resources
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Important Considerations Before implementing this strategy
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Clients should consider developing a comprehensive financial plan to take into account current and future income and expenses in conjunction with implementing any of the strategies discussed here.
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We recommend that clients consult their tax and legal advisors to discuss their situation before implementing any strategy discussed here.
About these concepts
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This concept is only suited to high net worth clients who do not rely on the assets for living expenses for the expected lifetime of the insured(s). It is the client’s responsibility to estimate these needs and expenses and it is recommended that they consider developing a comprehensive financial plan in conjunction with implementing the strategy being considered. The accuracy of determining future needs and expenses is more critical for clients at older ages who have less opportunity to replace assets used for the strategy.
If your client’s financial or legacy planning situation changes
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If clients need to use the assets or income in the strategy for current or future income needs and they can no longer make premium payments, the life insurance death benefit may terminate and the results illustrated may not be achieved.
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Important Considerations Tax and other financial implications
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There may be tax and other financial implications as a result of liquidating assets within an investment portfolio. If contemplating such a strategy, it is important for clients to understand that life insurance is a long-term strategy to meeting particular needs.
About life insurance
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The death benefit protection offered by a life insurance policy can be a key component of a sound financial plan. It is important for clients to fully understand the terms and conditions of any financial product before purchasing it.
Other notes
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Clients should consider that life insurance policies contain fees and expenses, including cost of insurance, administrative fees, premium loads, surrender charges, and other charges or fees that will impact policy values.
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If premiums and/or performance are insufficient over time, the policy could lapse, which would require additional out-of-pocket premiums to keep it in force.
Important Information This material has been prepared by The Prudential Insurance Company of America to assist financial professionals. It is designed to provide general information in regard to the subject matter covered. It should be used with the understanding that we are not rendering legal, accounting or tax advice. Such services should be provided by the client’s own advisors. Accordingly, any information in this document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal Revenue Code.
PruLife® SUL Protectoris issued by Pruco Life Insurance Company, except in New York where, it is issued by Pruco Life Insurance Company of New Jersey. Both are Prudential Financial companies located in Newark, NJ.
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NOT FOR CONSUMER USE
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