Advertisement
taxes

Worried about Estate Taxes? One Strategy to Try

If your heirs might face a big estate tax bill one day, an irrevocable life insurance trust could help protect your legacy.

Imagine having a thriving family business that you plan to leave to your heirs.

Or maybe there’s a substantial piece of land that you want to leave your children.

During the estate-planning process, however, you discover your beneficiaries will be subject to a $10 million tax bill. (That may sound impossible, considering the $11.4 million federal estate tax exclusion, but it can happen with a large family business — especially when you take into consideration possible state taxes.) And the only way for your estate to pay this tax liability, in the absence of additional advanced planning, may be to sell the family business or the land you hoped to pass on.

Advertisement - Article continues below

You don’t want your heirs to be forced into a fire sale, where they would have to take any offer just to liquidate as quickly as possible. But what can you do?

Fortunately, there is another way for people with multimillion-dollar estates to address these potential liquidity needs by using an irrevocable life insurance trust (ILIT) strategy.

How It Works

High-net-worth individuals and families often wonder about the best way to create a seamless estate plan. Though there are many options, trust-owned life insurance (TOLI) is frequently a good fit for those who have illiquid assets (such as businesses, land or qualified plans). It enables the trust to balance inheritances among beneficiaries estate-tax-free, which is one of the top issues among wealthy individuals. It’s also useful for individuals who want to give to charity when they die.

Advertisement
Advertisement - Article continues below

With an ILIT strategy, assets owned by the trust pass to the beneficiaries according to the grantor’s wishes, without being subject to federal estate taxes. This is possible because the owner is the trust, which now removes the proceeds from the insured’s estate. The trustee then maintains the policy or policies, which opens up the family to a variety of important tax-planning and charitable giving opportunities. At death, the death benefit proceeds will be paid to the designated beneficiaries of the trust both income and estate tax-free.

Advertisement - Article continues below

TOLI premiums are typically funded by annual exclusion gifts, but they also can be funded by using private financing or premium financing.

An Illustration: One Couple’s Story

To see this strategy in action, let's consider an example. Dr. & Mrs. Anderson have a $30 million estate and are approaching a $10 million tax bill upon their passing. They are somewhat “cash poor” but do not want to liquidate assets. Premium financing will prove to be beneficial to them. Let me explain how.

Fundamentally, premium financing is a planning strategy that enables Dr. & Mrs. Anderson to pay the premiums for the coverage they need without having to liquidate assets. The Andersons will come to an arrangement through which they will borrow money at a competitive interest rate from a bank to pay for their life insurance policy with an approximate $15 million death benefit. The policy cash value is generally used as the majority of the collateral for the loan.

Advertisement - Article continues below

Put visually, it would look like this:

Getty Images

By leveraging the lender’s capital rather than their own to pay annual premiums, they will be able to retain their capital in high-returning investments. The loan could be paid off from: 1) a portion of the death benefit proceeds upon the death of the insured, whether it is Dr. or Mrs. Anderson, 2) a tax-free withdrawal from a portion of the cash value, or 3) an asset sale in the future.

Advantages of Trust-Owned Life Insurance

Not only can this strategy help achieve effective tax planning, but it also allows for the proceeds to be used to help the estate pay expenses and taxes once the grantor passes away. This liquidity opportunity is available through a provision that allows the trust the discretion to purchase assets from either spouse’s estate or to make loans to either estate, which keeps cash available.

Advertisement
Advertisement - Article continues below

An ILIT also gives an individual the opportunity to donate to a charity while preserving an inheritance for any chosen beneficiaries. The ILIT provides a death benefit that replaces the value of the gift made to charity.

Advertisement - Article continues below

In addition, gifts made to the ILIT eventually will reduce the overall value of the estate, which will, in turn, reduce the amount that would be calculated in the taxable amount.

Potential Pitfalls

If you are thinking about gifting to your life insurance policy, it’s important to be aware of the gift tax liability. For 2019, any gift that is greater than $15,000 for the year ($30,000 for married couples) applies against the gift-tax exclusion and requires filing Form 709. So, the maximum premium you would be able to gift without gift-tax liability would be $30,000. Many times, this just isn’t enough to properly plan one’s estate.

Many people need large policies that require much more than what the annual gift exclusion allows to cover their needs. This is where premium financing can be a valuable tool for those who want to maximize their estate with a substantial life insurance death benefit and without having to liquidate and pay taxes on other investments to make large premium payments. Premium financing also avoids using up your annual gift tax exclusions and reducing your overall lifetime exemptions.

Advertisement - Article continues below

In addition, by leveraging a lender’s capital rather than your own to pay annual premiums, you retain a significant amount of capital you can use to maintain or make investments or preserve your savings or cash flow needs. If the policy performs favorably compared to the loan interest rate, premium financing offers you the opportunity to potentially earn a higher level of interest from the policy than the interest you pay for the loan. In essence, we finance our homes, our businesses and practically everything else, so why shouldn’t we finance our life insurance?

Advertisement
Advertisement - Article continues below

But premium financing does have some risks. For example, lending rates may increase to a higher level than projected, which may require posting collateral with the bank. Financial institutions typically require borrowers to provide collateral from liquid assets, such as securities, and if those securities decrease in value, the lender may require additional collateral. Longevity also can be a risk; the longer the insured individual lives, the greater the amount of cumulative loan principal and interest, which could reduce, and even possibly eliminate, the ILIT’s remaining net death benefit.

It’s Complicated, So Get Help

Though an ILIT strategy can be a valuable option for those who want to protect their estate from a burdensome (or even nightmarish) tax bill, it requires several complex legal and financial decisions. A premium-financed plan, in particular, can require constant monitoring. To help you navigate the nuances, you’ll want to tap an experienced and independent financial professional and an estate attorney.

As difficult as it is for you and your loved ones to think about your death, having a plan in place is the only way to ensure your legacy carries on. Gifting, taxes and charitable giving should be a priority if you hope to efficiently and effectively transfer the estate you worked so hard to build. If you don’t have a plan, I can assure you the government has one for you.

Kim Franke-Folstad contributed to this article.

Advertisement

About the Author

MIchael Jankowski, Investment Adviser Representative

President and CEO, Wealth Planning Network

Michael Jankowski is president and CEO of the Chicago-based wealth management and estate planning firm Wealth Planning Network (www.wpn360.com). A frequent seminar leader and lecturer, he specializes in working with physicians, business owners and corporate executives.

Advertisement

Most Popular

18 Things You Can't Return to Amazon
Smart Buying

18 Things You Can't Return to Amazon

Before tossing these items into your virtual shopping cart, be sure to read Amazon's return policy first.
September 17, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020
Insurance for Long-Term Care at Home
retirement

Insurance for Long-Term Care at Home

In the wake of COVID-wracked nursing homes, increasingly more people are looking at options to age in place with long-term care insurance.
September 17, 2020

Recommended

Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020
Now’s the Time for Estate Tax Planning
Financial Planning

Now’s the Time for Estate Tax Planning

There's a wealth of opportunity with IRS interest rates at an all-time low and the federal estate and gift tax exemption at an historic high.
September 18, 2020
Most-Overlooked Tax Breaks for the Newly Divorced
tax deductions

Most-Overlooked Tax Breaks for the Newly Divorced

Filing taxes after a divorce can add yet another problem to an already long list of challenges. But here are some tips to make your return to single l…
September 18, 2020
A Step-by-Step Guide to Being an Estate Executor
retirement

A Step-by-Step Guide to Being an Estate Executor

Whether you’re planning ahead for your own heirs or have been asked to serve as an executor of an estate for someone else, it pays to understand what …
September 17, 2020