It’s a corny title, but it describes the economic and tax story of Joe, a 79-year -old widower. Joe is generally a healthy and happy guy. He still works part-time every day at the successful business he started and subsequently transferred to his two sons. For relaxation, Joe hits golf balls and spends lots of time with his grandchildren.
However, Joe is not happy about the cost of funding the annual insurance premiums on his irrevocable insurance trust (ILIT). Joe’s ILIT owns a $4 million life insurance policy on his life with annual premium of $87,000. Yes, he needs the insurance to cover a portion of his potential estate tax liability. No, he couldn’t buy second-to-die (with a substantially lower premium cost) because his wife was uninsurable when the ILIT bought his policy. (Note: An ILIT protects the death benefits of a life insurance policy from the clutches of the estate tax. Now stop for a moment and look at your own insurance cost situation. You may find that you have similar complaints to Joe’s which are outlined below.)
Complaint #1. There is a potential estate tax liability. Every year, when Joe writes his check to the ILIT (for $87,000), he gets four annual exclusions of $11,000 each ($44,000 total), one for each of his two sons and two grandchildren. That leaves a taxable gift of $43,000 ($87,000 minus $44,000), which eats away at his $1 million lifetime unified credit. No cash gift tax is due at this time, (this means that the first $1 million of taxable gifts do not require cash to pay the gift tax, but are paid using the lifetime unified credit), but when Joe passes on, those annual taxable gifts will turn into an estate tax liability (most likely 55 percent of the total of all those annual taxable gifts).
Complaint #2. Premiums are more costly than projected. Interest rates are much lower now than when Joe bought the policy. This results in the premiums being more costly than the projections originally made by his insurance agent.
Complaint #3. The insurance premiums aren’t deductible. Joe has figured out that, in his tax bracket, he must earn $145,000 and pay $58,000 in income tax in order to have the $87,000 needed to pay his premium (actually to make the gift to the ILIT). Joe thinks that life insurance premiums should be deductible, but that is unlikely to happen because it takes an act of Congress to change the Internal Revenue Code.
Readers of this column know that I have a network of professionals (lawyers, insurance consultants, appraisers and others) to help me find a solution to such problems. So I (“the tax knight”) and my network (“merry men”) went in to rescue Joe.
We had Joe’s ILIT restructure his insurance using a strategy called “premium financing” (PF). With PF, policy premiums are paid by a lending bank. Like before, Joe’s PF policy is owned by the ILIT. When Joe dies, the bank loans and accrued interest on the loans will be paid out of the policy proceeds.
Joe’s PF is set up for $5 million (net proceeds after paying off the bank) to go to the ILIT, and the beneficiaries are his kids and grandkids. Joe’s only potential out-of-pocket costs are $60,000 (to initiate the bank loan) the year the PF is set up. If Joe lives to be 100, then the total additional cost will be $352,000, with varying small amounts to be paid each year (to maintain the loan). Of course, if Joe dies sooner, these costs stop.
What were the final results for Joe by using PF? To start, there are no more $87,000 annual premium payments—actually, there are no more premium payments at all. All three of his complaints have disappeared. There are no out-of-pocket costs: not even the potential out-of-pocket costs of $60,000 or any portion of the $352,000. Why? Because the cash surrender value (CSV) of the original $4 million policy owned by his ILIT was more than enough to cover all of the PF costs. The old policy was cancelled to free up the CSV and put the PF strategy in place without any further costs to Joe.
PF is a relatively new concept. It is easy to understand but complex to implement (it really takes a network of experienced professionals working together). The results however, create an economic windfall.
Not everyone can take advantage of PF. To qualify, you must bring two things to the table: 1) you must be insurable (if married, one spouse must be insurable so your ILIT can buy second-to-die coverage, and 2) you must be credit worthy (worth a minimum of $5 million). Actually, the more you are worth and the more liquidity you have, the more likely you will qualify for this sought-after strategy.
I have arranged to have my network review the individual situations of readers of this column who are interested in PF. Just fax your name, birthday (include your spouse, if married), net worth and phone numbers (business, home and cell) to me at (847)674-5299). Please call me at (847) 674-5295 if you have any questions.