Save Taxes – Basics of an Irrevocable Life Insurance Dynasty Trust

For US persons, an irrevocable life insurance trust (ILIT) is arguably the most efficient structure for integrating tax-free investment growth, wealth transfer and asset protection. An ILIT comprises two main parts: (1) an irrevocable trust; and (2) a life insurance policy owned by the trust. An international (or offshore) ILIT is a trust governed by the law of a foreign jurisdiction that owns foreign-based life insurance. An offshore ILIT is better than a domestic ILIT because it is more flexible and less expensive. Regarding US tax laws, a properly designed international ILIT is treated virtually the same as a domestic ILIT.

An ILIT becomes a dynasty trust (or GST trust) when the trust’s settlor (or grantor, the person who establishes and funds the trust) applies his lifetime exemption for the generation skipping transfer tax (GSTT) to trust contributions. Once a dynasty trust is properly funded by applying the settlor’s lifetime exemptions for gift, estate and GST taxes, all distributions to beneficiaries will be free of gift and estate taxes for the duration of the trust, even perpetually. The individual unified gift and estate tax exemption and the GSTT exemption are both $5 million ($10 million for a married couple) during 2011 and 2012, which are the highest amounts in decades.

Under the US tax code, no income or capital gains taxes are due on life insurance investment growth, and no income tax is due when policy proceeds are paid to an insurance beneficiary upon death of the insured. When a dynasty trust purchases and owns the life insurance policy and is named as the insurance beneficiary, no estate tax or generation skipping transfer taxes are due. In other words, assets can grow and be enjoyed by trust beneficiaries completely tax-free forever. Depending on how a trust is designed, a portion of trust assets can be invested in a new life insurance policy each generation to continue the cycle.

Private placement life insurance (PPLI) is privately negotiated between an insurance carrier and the insurance purchaser (e.g., a dynasty ILIT). Private placement life insurance is also known as variable universal life insurance. The policy funds are invested in a separately managed account, separate from the general funds of the insurance company, and may include stocks, hedge funds, and other high-growth and/or tax-inefficient investment vehicles. Offshore (foreign) private placement life insurance has several advantages over domestic life insurance. In-kind premium payments (e.g., stock shares) are allowed, whereas domestic policies require cash. There are few restrictions on policy investments, while state regulations restrict a domestic policy’s investments. The minimum premium commitment of foreign policies typically is US$1 million. Domestic carriers demand a minimum commitment of $5 million to $20 million. Also, offshore carriers allow policy investments to be managed by an independent investment advisor suggested by the policy owner. Finally, offshore policy costs are lower than domestic costs. An election under IRC § 953(d) by a foreign insurance carrier avoids imposition of US withholding tax on insurance policy income and gains.

Whether domestic or offshore, PPLI must satisfy the definition of life insurance according to IRC § 7702 to qualify for the tax benefits. Also, key investment control (IRC § 817(g)) and diversification (IRC § 851(b)) rules must be observed. When policy premiums are paid in over four or five years as provided in IRC § 7702A(b), the policy is a non-MEC policy from which policy loans can be made. If policy loans are not important during the term of the policy, then a single up-front premium payment into a MEC policy is preferable because of tax-free compounding.

An offshore ILIT provides much greater protection of trust assets against creditors of both settlor and beneficiaries. Courts in the US have no jurisdiction outside of the US, and enforcement of US court judgments against offshore trust assets is virtually impossible. Although all offshore jurisdictions have laws against fraudulent transfers, they are more limited than in the United States. In any case, an offshore ILIT is necessary to purchase offshore life insurance because foreign life insurance companies are not allowed to market and sell policies directly to US residents. An international trust, however, is a non-resident and is eligible to purchase life insurance from an offshore insurance carrier.

An international ILIT may be self-settled, that is, the settlor of the trust may be a beneficiary without exposing trust assets to the settlor’s creditors. In contrast, in the United States, the general rule is that self-settled trusts are not honored for asset protection purposes.

In Private Letter Ruling (PLR) 200944002, the IRS ruled that assets in a discretionary asset protection trust were not includable in the grantor’s (settlor’s) gross estate even though the grantor was a beneficiary of the trust. The trustee of a discretionary trust uses his discretion in making distributions to beneficiaries consistent with trust provisions. Previously, it was questionable whether a settlor could be beneficiary of an ILIT without jeopardizing favorable tax treatment upon his death. The new ruling gives some assurance to a US taxpayer who wants to be a beneficiary of a self-settled, irrevocable, discretionary asset-protection trust that is not subject to estate and GST tax. As a result, the trustee can (at the trustee’s discretion) withdraw principal from the PPLI or take a tax-free loan from the policy’s cash value and distribute it tax-free to the settlor, as well as to other beneficiaries. In other words, a settlor need not sacrifice all enjoyment of ILIT benefits in order to achieve preferred tax treatment.

An offshore ILIT is designed to qualify under IRS rules as a domestic trust during normal times and as a foreign trust in case of domestic legal threats to its assets. The offshore ILIT is formally governed by the laws of a foreign jurisdiction and has at least one resident foreign trustee there. As a “domestic” trust under IRS rules, the trust also has a domestic trustee who controls the trust during normal times. If a domestic legal threat arises, control of the trust shifts to the foreign trustee, outside the jurisdiction of US courts, and the trust becomes a “foreign” trust for tax purposes. A domestic trust “protector” having negative (or veto) powers may be appointed to provide limited control over trustee decisions. An international ILIT protects trust assets against unforeseen lawsuits, bankruptcy and divorce.

The objective of PPLI is to minimize life insurance costs and to maximize investment growth. The life insurance policy acts as a “wrapper” around investments so that they qualify for favorable tax treatment. Nevertheless, PPLI still provides a valuable life insurance benefit in case of an unexpected early death of the insured.

Initial costs of setting up an ILIT are high, but are recouped after a few years of tax-free investment growth. Initial legal and accounting fees are typically in a range of $25,000 to $50,000. Premium “loading” charges are in a range of about 3% to 5% of premiums paid into offshore PPLI (compared to 8 – 10% in domestic PPLI). Annually recurring charges depend on policy value and vary widely among PPLI carriers, so careful comparison shopping is advised. For example, annual asset charges should be in a range of about 40 to 150 basis points (0.4% to 1.5%) of the policy’s cash value. The annual cost of insurance is not substantial and declines over time. Annual costs for maintaining an offshore trust are several thousand dollars. Finally, investment manager fees are paid regularly out of policy funds.

Cash may be contributed to the ILIT, which then purchases PPLI. If asset protection of vulnerable fixed assets in the US is a concern, then equity stripping can be used to generate cash, which is then contributed to the offshore ILIT. Of course, stocks and bonds and other assets may also be contributed to the ILIT and used for investing in PPLI. Various value-freezing and valuation discounting techniques can be used to leverage the GSTT exemption.

An offshore “frozen cash value” policy is a variation of PPLI governed by IRC § 7702(g). The minimum premium commitment is about $250,000. During the life of the insured, the cash surrender value is fixed at the sum of the premiums paid. Withdrawals up to the amount of the paid-in premiums are tax-free, but cash value in excess of the premium amounts is inaccessible until after death of the insured.

Another alternative investment for an ILIT is a deferred variable annuity (DVA). There is no cost of insurance, so investment growth is faster. Tax on appreciation is deferred, but DVA distributions are taxed as income.

Generally, for public policy reasons and because the insurance industry possesses strong political influence, life insurance has long enjoyed favorable tax treatment. Over the past two decades, numerous IRS rulings have clarified the tax treatment of PPLI and irrevocable discretionary trusts. At the same time, strong, new asset protection laws and reliable service providers in numerous foreign jurisdictions have enabled safe, efficient and flexible management of international trusts and insurance products. As a result, an international irrevocable, discretionary trust owning PPLI can provide tax-free growth of a global, variable investment portfolio managed by a trusted financial adviser in full compliance with US tax laws. At the discretion of the trustee, trust assets (including tax-free insurance policy loans and withdrawals) are available to the settlor during his lifetime. Upon death of the insured, policy proceeds are paid tax-free to the trust. Thus, a well-managed life insurance dynasty trust perpetually secures the financial well being of settlor, spouse, children and their descendants.

Warning & Disclaimer: This is not legal advice.

Copyright 2011 – Thomas Swenson

Life Insurance: How Much and What Type To Own?

Do you need 5 times your income? Or do you need 10 times your income?

In my experience, if you ask stupid questions you tend to get stupid answers.

The real question you should be asking yourself is… If I die tomorrow, what do I want financially for the loved ones I will leave behind?

Will your spouse need an income? How much? For how long?

If so, how much money does it take today to provide that amount of income?

What assets do I have to help offset that number?

Are there any debts that must be paid off?

Will your kids need money to pay for college?

Is there a parent or another family member that depends on you?

Do you want to leave money to your church or Alma Mater?

Once you know the answers to the above questions, work with a qualified, unbiased professional like a Fee-Only Certified Financial Planner who can help you determine the correct amount of life insurance you really need.

Don’t use rules of thumb to plan your financial life! Here’s why:

Let’s assume you die tomorrow, and you need to replace your current income of $50,000 for the next 20 years to allow your husband/wife and kids to keep their same lifestyle without having to struggle. If you used the “rule of thumb” of 10 times your income when you bought your life insurance, your surviving spouse and kids will most likely run out of money in 15 years or less. Feel free to email me and I would be happy to send you the hard data.

What Type of Life Insurance Do You Need?

Let’s start off with the basics. There are two main types of life insurance: Term and Permanent.

Both are conceptually easy to understand. Term Life Insurance covers you for a specified period or term, like 20 years for example. Permanent Life Insurance covers you permanently or for your entire life, or at least it’s supposed to. Permanent Life can have many sub-names like whole life, variable life, universal life or single premium life which all work differently.

When you purchase Term insurance, you are only paying for the cost of insurance which is usually very inexpensive. In a Permanent policy, premiums are usually substantially higher than term. Some of the premium goes towards the cost of insurance and the remainder builds in an account called the “cash value.” Cash values typically grow tax deferred.

You have probably heard all the media “hubbub” about which type of life insurance you should purchase. Radio show pundits and magazine articles tell us to only purchase term, or whole life is a bad investment, or own term and investment the difference.

Are those things really true? Is it really that simple? What’s the truth?

Well, honestly the type of life insurance you should purchase depends on many things. Some people only need term but others may need permanent.

Tell me exactly how long you will need life insurance and when you will die, and I can tell you the correct type you should own. But like most other financial planning decisions, we must make some assumptions or best guesses about the future. But it’s very difficult to know when you are 20, 30 or even 40 what your financial life will really be like at age 60.

Here are some truths:

  1. Most permanent policies are junk! But not all.
  2. Any type of life insurance is usually better than NO life insurance.
  3. Most people should buy life insurance for protection only NOT as an investment.
  4. Most people who end up buying the wrong type of life insurance got their advice from an insurance agent, not an objective financial planner.

This issue is way to complex for me to cover every detail in a blog post. My hope here is to get you to understand the basics so you can go hire a professional to help you that isn’t a financial sales person.

You most likely need Term if:

  • You are just starting out
  • Have no discretionary income and/or low net worth
  • It’s very easy to forecast the length of your insurance need (10 years left on a mortgage for example)
  • Have a very limited amount of savings left over for retirement
  • You simply can’t afford permanent insurance, even it were a good deal

When Permanent Life may be a fit:

  • Very strong, predictable cash flow
  • High income earner
  • You have exhausted all possible retirement savings vehicles (401k, Roth, etc.)
  • Will have Estate Planning liquidity issues
  • It’s very hard to predict the age you will no longer need life insurance
  • You just want your life insurance to be there when you die!
  • You have done your research! Not all life insurance policies are equal!
  • You understand all the workings of the policy (expenses, interest rate, etc)

Why does Permanent Life insurance get such a bad rap? I believe most people fear what they don’t understand. And Permanent insurance can be extremely difficult to understand. Also, most Permanent Life policies have too many internal expenses which can make them a terrible deal. But some companies do a pretty good job of keeping internal costs down, therefore increasing the internal rate or return on your “cash value.”

Here is one concept:

Most term polices never pay a death benefit because people out live them or cancel them. Let’s say you compare 2 options: 1.) invest money in a taxable investment OR 2.) buy permanent life insurance where your policy builds cash value. If the cash value of your life insurance net of expenses could earn more than your investment account net of taxes, then you would have more money inside the cash value. OR vice versa. Sounds simple, right? Not exactly!

You want to make sure you are comparing apples to apples. If the cash value grows at a fixed rate, then compare it to fixed income assets in your investment account. If your investment account is invested in stock mutual funds, compare it to a comparable allocation in Variable Life. This is where the media falls short on helping you understand Permanent life insurance. They try to compare fixed rate cash value insurance to the stock market over the long-term. That’s like comparing a Porsche to a Subaru!

But it’s not all about the cash value rate of return. What about the rate of return on the death benefit? Like I mentioned earlier, this issue is far too complex to cover all the points here!

Here is your take away. Term Insurance is right for many Americans. Some types of Permanent policies may be a fit for others. It just depends on the unique situation of the individual. This can be a very confusing area. Seek out unbiased, objective advice from a Fee-Only Certified Financial Planner. www.jasonWqualls.com

Finding Affordable International Travel Insurance

Most people enjoy traveling abroad, but there are some risks involved in the trips. No one wants accidents to happen but they do because we have no control over them. This means that you should never travel without international travel insurance which can be of great help in case you find yourself in trouble in a foreign country. The insurance policy should cover for any loss of baggage, illness and also death.

Some people feel strong and think that they can take care of themselves. However, you are wrong because you never know what will happen to you. Get cheap international travel insurance and you will be in a position to pay your medical bills when involved in an accident. People keep losing their baggage while on trips and you should not count yourself out. Keep yourself and your items covered with an insurance policy and things will be easy even when you get into problems. In a foreign country, you have no one to help you, but you can turn to your insurance company and claim compensation on all the items lost.

Getting international travel insurance helps you to remain calm and at peace while traveling. You will not be thinking of financial losses once you get good travel insurance cover. The travel insurance should compensate you if you are delayed during the trip. Cancellations can also cause you financial loss and you need to be compensated. To most people, travel insurance is about medical expenses. This is also good for you because you get health care without delay and the bills are cleared for you. Make things easy by getting insurance cover and your trip will be smooth without any problems.

To some people, international travel insurance is wastage of money but this is something vital and you may put your life at risk. Having an insurance cover you can think straight and also be sure of compensation if things fail to go in the right way. When looking for the cheapest insurance cover, always consider the services provided and not the price. This will ensure that you get the best to keep you protected. This is one of the most important things that you need to do when getting ready for a trip.

You need to understand that the benefits of international travel insurance are more than what you invest when applying for the insurance policy. Visit several website and see how insurance companies help in your situation which can be too costly for you. Taking sometime to do some research will ensure that you get the best out of your money. You can only do this by comparing the quotes before you purchase the policy. This will make you get affordable travel insurance and enjoy all the quality protection that you require on your trip.

Make sure that you get international travel insurance before you leave your country. Do no risk thinking that everything will be fine, it’s better to be safe than sorry.