An Irresistible Plan for Life Insurance on Heirs Using the Private Leveraged Benefit PlanÔ

Almost all parents of means who have used life insurance in their own estate plans are responsive to giving their children a head start on the life insurance they will need later in life provided the funding is not unreasonably expensive.

How about funding that is recoverable? This approach is what made private equity split dollar so attractive; however, with the advent of IRS Notice 2002-8 and the proposed split dollar regulations issued in July 2002, new private equity split dollar plans are no longer viable. (In-force private equity split dollar plans are arguably goners, too.)

Imagine proposing the following to a good estate planning client:

Suppose you could . . .

1. Loan $160,000 to an irrevocable trust formed, for example, on behalf of your 20-year-old son or grandson or daughter or granddaughter
2. Charge a loan interest rate of 4.80% (which the IRS agrees is sufficient)
3. Have the trust use the $160,000 to acquire a $2,500,000 life insurance policy insuring your 20-year-old son or grandson or daughter or granddaughter
4. Have the policy develop long-range illustrated cash values of $3,500,000 (using a universal life policy) or perhaps in excess of $25,000,000 (with a variable universal life policy)
5. Restrict your son's or grandson's or daughter's or granddaughter's access to the funds in the policy until the term of years you decide is appropriate.
6. Gift the trust the funds it needs to pay you the loan interest due
7. Have the trust return those gifts immediately as non-taxable loan interest
8. Have the trust repay the $160,000 loan anytime after 10 years

See below for a graphic rendering of the illustrated values for each policy.

Universal Life:

Variable Universal Life:

Source of the Graphics: Private Leveraged Benefit Plan module in the InsMark Section 7872 Illustration SystemÔ .

Note: Cash values and death benefits are illustrative only and may be higher or lower than shown. In actual presentations, each graph must be accompanied by a "basic" illustration from the issuing life insurance company and, in the case of the variable life policy, a prospectus, both of which contain important details, guarantees, and caveats.

We have written several reports in this Wealth Concepts series on uses of the Private Leveraged Benefit Plan; however, this is the first time we have demonstrated it insuring the life of an heir. The mechanics, except for the insured, are similar.

Here is how the plan works:

• An "intentionally defective" irrevocable life insurance trust is established. (More on this below.)

• The trust borrows funds from the trust Grantor (who is typically one or both of the parents or grandparents) at the Applicable Federal Rate in effect on the date the loan is made as established under IRC Sec. 7872.
• Generally, the loans are long-term loans (more than 9 years), although mid-term loans (over 3 years but not over 9 years) or short-term loans (3 years or less) can be used. Demand loans with annually changing interest rates can also be used; however, in most cases, term loans are preferred since interest rates can be tied down for longer periods of time. The variations we will illustrate shortly will reflect long-term loans.
• Loan interest is paid by the trust in cash. (In some cases, loan interest is accrued or partially accrued.)
• Gifts are made to the trust to cover whatever loan interest the trust pays in cash.
• The trust uses the loan proceeds to purchase a life insurance policy on a family member of a future generation (son, grandson, daughter, granddaughter).
• Policy cash values and death benefits secure the loan.

Normally, loan interest is taxable; however, the trust associated with the Private Leveraged Benefit Plan is a so-called "intentionally defective" Grantor Trust. Under Grantor Trust rules that apply, 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, IRS Reg. 1.671-2(c), and Rev. Rul. 85-13.) This means that the gifts to the trust are immediately returned to the Grantor/Lender as non-taxable loan interest.

Although the plan is cash flow neutral in this respect, the gifts to the trust require use of annual gift exclusions (or, in some very large cases, use of part of the lifetime gift exemption); however, the loan to the trust is not subject to gift tax limitations. (One way to avoid this consequence with very large cases is to accrue some or all of the interest.

Illustrations: Two sets of illustrations accompany this report (click here to view the illustrations). The insured is Tom Contini, the 20-year-old son of Frank and Angela Contini, a wealthy couple in their mid-forties.

The first set of illustrations (Pages 1 through 16) involves a $2,500,000 universal life policy @ 6.00% and the second set (Pages 17 through 28) reflects a $2,500,000 variable universal life policy @ 10.00%. I will leave it to your and the Contini's good judgment as to which policy is more appropriate for Tom.

Frank and Angela are vitally aware that loan interest rates are at a generational low; consequently, we have designed a short-pay premium-paying period ($35,000 a year for five years -- just enough to avoid MEC status with the issuing carrier) and, in order to lock down the March 2003 Applicable Federal rate of 4.80% for the entire transaction, we are utilizing what InsMark calls a Premium Reserve Account ("PRA").

With the PRA, the Continis loan the trust all the funds needed to cover all the scheduled premiums -- five years' worth, in this case. From this amount, the trust pays the initial premium of $35,000 and uses the balance as a sinking fund to pay the remaining premiums as they fall due.

Five times $35,000 would indicate a $175,000 loan; however, the Contini's are willing to assume that the trust can earn a little interest on the PRA so, in this case, they loan the trust $162,050. (This assumes the trust can earn a tax exempt yield of 4.00%.)

You can see the calculations for the PRA on Page 7 of the universal life illustrations and on Page 19 of the variable universal life illustrations. (The PRA is identical in both cases.) (Click here to view the illustrations)

Both sets of illustrations assume the trust uses a policy loan in year 20 to repay the loan to Frank and Angela. (There is no magic inherent in year 20 -- loan repayment could occur earlier or later.)

In this case, coordinated with the scheduled loan repayment, the trustee of the trust is empowered to distribute the policy to Tom at the end of 20 years. Tom does not yet have any children, so should Tom die prior to their presence, the trust is empowered to support other family members. After children are on the scene, the trust is empowered to place them in a preferential position.

Conclusion: Although the Private Leveraged Benefit Plan is typically used to fund life insurance policies on the life of clients like Frank and Angela, for a relatively small secured loan of $162,050 (small at least for the Continis), Frank and Angela can bring this outstanding concept into play for their son, Tom, who is well on his way to a lifetime of valuable protection containing an impressive array of illustrated cash values which will form the foundation of his non-qualified retirement "bank".

Note: This plan is in full compliance with IRS Notice 2002-8 and the proposed split dollar regulations issued in July 2002 for so-called "loan regime" plans.

Background: This is a general description of an actual case from one of InsMark's Power Producers that involves similar plans on five adult children. If you have wealthy estate planning clients, you may want to bring this technique to their attention.

Licensing: Both the Private Leveraged Benefit Plan and the Leveraged Benefit PlanÔ (cast between employees and valued executives) are available in the InsMark Section 7872 Illustration System. The Leveraged Benefit Plan has also been featured in several previous reports in this Wealth Concepts series.

The InsMark Section 7872 Illustration System is available for licensing now. Please call an InsMark Account Executive at 1-888-InsMark (467-6275) for details, or click here.

Insurance companies and other institutional firms interested in multiple units or site licensing should contact David A. Grant, Senior Vice President, Sales, at 1-925-543-0500.

Specimen Documents: Licensees for the InsMark Section 7872 Illustration System are furnished with several specimen documents used to establish the loan transactions.

Workbooks: Licensees for the InsMark Section 7872 Illustration System can review all reports and related menu inputs for the accompanying Private Leveraged Benefit Plan illustrations by selecting the Workbook named MA148.!LB from this website.

To go to the Workbook download page on our website, click on Producer's Center; then on Workbook Download (one of the icons at the top of the page). After you download the Workbook files, you can import them into their respective Systems by clicking on Client Workbook / Import Workbook on the main menu bar. To download the Workbook now, click here.

Important Notice: In all cases, the approval of a client's legal and tax counsel must be secured before implementing a Private Leveraged Benefit Plan.

P.S. Use of the Premium Reserve Account ("PRA") has heavy-duty impact for very large estate planning cases. Here is an example: A couple we are very close to has eight children, all of them married. There are currently eighteen grandchildren. That produces 68 (34 times 2) annual gift exemptions for this couple. $11,000 (the current annual gift exclusion for each) times 68 equals $748,000 in annual tax free gifts without using a dime of their lifetime exemption. Assuming an Applicable Federal Rate (long-term) of 4.80%, annual gifts of $748,000 can support a $15,583,333 loan to a trust to establish a Premium Reserve Account. Using a five premium "quick-pay", if the trust-owned PRA can earn 4.00% tax free, the amount of each premium it can support is $3,365,806. (With a 20-pay approach, the premium can be $1,102,547.)

Can you think of any other way to generate this level of estate planning premium in an irrevocable trust without using any of the lifetime gift exemption or generating a dime of gift tax? And please don't say "limited collateral assignment split dollar" as that plan produces advanced age economic benefit that can terrorize a family's finances with immense imputed gifts of a future interest. See the article Private Split Dollar Rescue Opportunities for a discussion of this problem.)

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