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The Private Leveraged Benefit Plan This article introduces a powerful new wealth preservation concept called the Private Leveraged Benefit PlanÔ ("Private LBP"). It is part of the new InsMark Section 7872 Illustration SystemÔ -- and Private LBP is a cousin to the Leveraged Benefit Plan discussed in the previous three articles in this series (click here to access). Private LBP is a strategy used in conjunction with an irrevocable life insurance trust ("ILIT"). Typically, ILITs are funded with gifts that are used to purchase a life insurance policy, as follows:
With Private LBP, the ILIT also purchases a life insurance policy, but it does so with funds acquired via loans, as follows:
Here are the steps in the Private LBP transaction:
The major reason to use loans to fund the policy instead of gifts is because gifts are limited by the lifetime gift exemption and available annual exclusions. Loans are not bound by such rules. The gifts made to the Trust to cover loan interest might, at first glance, look counterproductive since they appear to be returned to the Lender/Grantor as taxable interest; however, the Trust associated with the Private LBP is a Grantor Trust. Under Grantor Trust rules, the Trust and the Lender/Grantor are a single income tax entity, and income tax consequences on transactions between the Lender/Grantor and Trust are ignored. (IRC Secs. 671 and 675, Treasury Reg. 1.671-2(c), and Rev. Rul. 85-13.) Consequently, with Private LBP, gifts to the Trust for loan interest payments are returned to the Lender/Grantor without taxation. A key issue to consider is this: Does the loan to the Trust contaminate the estate tax free nature of the life insurance proceeds? Fortunately, the IRS has issued a Private Letter Ruling ("PLR") on this subject that says it does not (PLR 9809032). While applicable only to the taxpayer to whom it is directed, this PLR specifically states that the payment of premiums with borrowed funds is irrelevant in determining whether the deceased retained any incidents of ownership under Reg. Section 20.2042-1(c)(2). The PLR also quoted as precedent two well-established court cases dealing with the same subject: Estate of Leder v. Comm., 893 F.2d 237 (10th Cir. 1989) and Estate of Headrick v. Comm., 918 F.2d 1263 (6th Cir. 1990). These were the two cases that caused the IRS to give up its fight to include the proceeds of a policy in the estate of whoever provided the funds for the premiums. Case Study Background: Jerry and Janet Grant are ages 65 and 60 respectively. They are interested in acquiring $10,000,000 of second-to-die coverage in the most efficient manner. You may review illustrations showing how they might use Private LBP by clicking here. Plan Design Comments: The Private LBP data illustrate a constant Sec. 7872 loan interest rate of 5.62% (the April 2000 rate). On plans with a series of annual loans, the interest rate on new loans must bear the appropriate Sec. 7872 interest rate (also known as the Applicable Federal Rate) in effect during the month each new loan is executed. This introduces an "unknown" into the illustrations. There are four ways to deal with unknown future Applicable Federal Rates:
The renegotiation option offers the most creative solution. Let's examine why that is. The illustrations for this presentation were put together in April 2002 -- and we used the Applicable Federal Rate -- 5.62% -- in effect for that month. Interest rates can go up -- and go down -- but once a given rate is locked in for a term loan, it freezes. (That's for a term loan -- as opposed to a demand loan.) The attached illustrations for the Grants involve five annual loans -- so we can freeze the loan interest for the first loan at 5.62% -- the rate in effect during the month the illustration was prepared. What about the remaining four loans? Let's examine a renegotiation technique that can be used to control the long-term interest rate. In the following Table, we went back 10 years to 1992 to research the recent history of the Applicable Federal Rate. In the Table below, you can see the highest rate and the lowest rate occurring in each of those years. As you can see, there is significant movement within the years -- as well as year-to-year.
Now look at the next Table. If a policy with five scheduled premiums -- funded by Section 7872 loans -- had been purchased in 1992 -- and been unlucky enough to catch the highest rate over the next five years, that purchaser would have ended up paying a Composite -- or average -- rate on all the loans as shown in the shaded row at the bottom of the second Table. In 1993, for example, there would be two loans -- one at 7.89% made the previous year and the new one -- at 7.30% made the second year -- for a composite rate of 7.60% -- and so on across the bottom row of the second Table. By the 5th year (1996) the last of the five loans would have been made -- and the permanent composite -- or average -- would have frozen then at 7.76%.
Just as many of you watch mortgage rates to decide if and when to refinance -- suppose we watch the lows that occurred and refinance the loan interest rates the same way. The third Table shows this strategy in which all loans are initiated at the highest rate in the year shown -- but renegotiated in years in which a lower rate becomes available.
With this approach -- with the exception of 1992 -- the average rate stays well below the rates shown in the second Table. By year 5, the composite -- that's the shaded row at the bottom -- is down from 7.76% to 6.25% -- and by the seventh year, it's down from 7.76% to 5.10%. It slips even further -- to 5.05% -- in the 10th year. While this example may not be representative of all 10-year cycles, it's pretty instructive in how the effect of a spike in the Applicable Federal Rate can be controlled. Illustration Resources: Licensees for the InsMark Section 7872 Illustration System can review all reports and related menu inputs for the accompanying Private LBP illustrations by selecting the Private LBP Workbook B-1 from the Sample Client workbooks available under Help on the System's main Toolbar. Licensees for Version 6.1 of InsGiftÒ -- the Wealthy and WiseÔ System ("InsGift") can review how we import data from Private LBP into InsGift to include its effect on an overall estate plan (for another couple) by reviewing Sample Client Workbooks J1 and J2 -- under Help on the InsGift Main Toolbar. If you are not licensed for the InsMark Section 7872 Illustration System, please contact us at 1-888-InsMark (467-6275) for licensing information. Private LBP includes a comprehensive, personalized Computer Business Card ("CBC") produced in PowerPoint. Licensees have rights to distribute copies of this CBC, and it is a superb promotional piece for advisers as well as useful for seminars. InsMark's Platinum-Level Power Producers are provided with the InsMark Section 7872 Illustration System as part of their master license. InsMark's Gold-Level Power Producers have the option to include it when they enroll. Power Producers enjoy a higher level of marketing and technical support and have access to marketing opportunities not available to other licensees. If you are interested in knowing more about this program ask the Account Executive who answers at the above number for additional information. As a final note, if your practice involves estate planning uses of life insurance, you don't want to run into Private LBP in competition. We recommend you arm yourself with it. |
