Memorandum. Rowbotham. January Offshore Variable Universal Life Insurance Concept

Transcription

1 Rowbotham & COMPANY LLP Memorandum January 1999 FROM: RE: Brian Yacker Offshore Variable Universal Life Insurance Concept Before the enactment of the new foreign trust and foreign gift reporting provisions contained in the Small Business Job Protection Act of 1996, foreign persons, through utilization of a foreign grantor trust, could take advantage of the then-existing grantor trust rules to transfer income-generating assets to U.S. beneficiaries without subjecting those beneficiaries to United States income taxes. However, after the passage of these new foreign trust rules, this tax planning technique was severely limited. Regarding the U.S. beneficiaries of foreign non-grantor trusts, the new foreign trust rules did not change the fact that they are taxable upon the receipt of income distributions from such foreign non-grantor trust. In order to best address these issues created by the enactment of the new foreign trust rules, taxpayer clients need an effective strategy to protect their interests. This effective strategy should be one that offers tax-advantages to preserve the wealth that the taxpayer client has worked so hard to accumulate. One of the best strategies to preserve wealth is to ensure that the appreciations upon that wealth are not taxed. By taking advantage of existing United States insurance tax rules, taxpayer clients can implement such an effective strategy, namely creation of an Offshore Variable Universal Life Insurance structure. Specifically, through the utilization of an Offshore Variable Universal Life Insurance policy in conjunction with a foreign trust, a taxpayer client can realize the following substantial benefits: Tax-free appreciation of investments Substantial liquidity in the investment account Low-cost borrowing from the investment account Tax-free receipt of the death benefit 1 Death benefit bonus 2 1 This can be a huge advantage for the current beneficiaries of the foreign trust being that this death benefit can be quite substantial if the policy is in existence for a long period of time. 2 The death benefit bonus arises when investing in an Offshore Variable Universal Life Insurance policy is compared to traditional investing in the financial markets. When compared to traditional investing, Offshore Variable Universal Life Insurance distinctively offers the payment of a substantial death benefit upon the death of the insured.

2 Tax-Free Investment Appreciation As the Internal Revenue Code ( IRC ) is currently structured, there is no United States tax upon the appreciation in value or accumulation of income of the investment account maintained within an insurance wrapper. 3 What this means is that all investments held within an insurance policy are permitted to appreciate tax-free without either the grantor, the trust itself, or the beneficiaries being liable for any ordinary income tax or capital gains tax upon the investment appreciation. This results in increasingly large tax savings (and hence greater net investment returns) the longer the insurance policy is in existence. Liquidity (Loans) Insurance products generally provide the policyholder with the ability to borrow funds (at any time) from the underlying investment account at below-market interest rates with no corresponding adverse United States income tax consequences. Thus, the policyholders of an insurance policy can have easy access to a substantial amount of their invested funds (including the appreciation upon those invested funds) on a tax-free basis through the mechanism of taking out policy loans. However, a policyholder usually cannot take all of the investment funds out of the investment account in the form of loans. This is because the underlying investment account must contain enough funds in order to annually cover the costs of insurance ( COI ) fees and other administrative charges. As a very general proposition, it is estimated that policyholders can take out between 80% and 90% of the existing amounts in their investment accounts in the form of loans. As such, the amounts in the investment account can be considered to be almost totally liquid. 4 Tax-Free Death Benefit Pursuant to 101(a) of the IRC, gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract. As such, distributions of the death benefit amount from an insurance policy (upon the death of the insured) to the beneficiaries of such underlying life insurance policy are tax-free. Additionally, the distribution of the death benefit amount to the beneficiaries can be free of estate and generation-skipping taxes if the insurance policy s ownership is structured properly through a third party (such as an irrevocable life insurance trust). Accordingly, the potential taxes on the investment appreciation within the insurance wrapper are not just deferred, they are completely eliminated since the beneficiaries are not taxed upon receipt of the death benefit. 3 But please be aware that no tax deduction is permitted for investment losses recognized inside the insurance wrapper. 4 With the additional benefit of being able to be accessed tax-free. Conversely, in regards to a traditional investment account, one must dispose of various investments (usually at a taxable gain) to withdraw funds from the account.

3 An investment in an Offshore Variable Universal Life Insurance policy will generate all of the abovedescribed benefits for the participants in such. Additionally, an Offshore Variable Universal Life Insurance policy will also generate the following additional advantages: Lower cost structure compared to domestic insurance alternatives Greater access to cutting-edge investment funds Asset protection Lower Cost Structure Domestic life insurance has traditionally been burdened with high sales acquisition costs, high administrative charges, and prohibitive commissions for the seller of the insurance. 5 Additionally, some domestic insurance companies also impose substantial additional loads and charges to help cover their overhead costs. Conversely, the Offshore Variable Universal Life Insurance programs (the ones which are currently operational) generally have much lower cost structures. This is primarily because the administrative fees and sales commissions for these offshore programs are generally significantly lower than those fees and commissions for domestic retail life insurance. Greater Access to Cutting-Edge Investment Funds Since Offshore Variable Universal Life Insurance programs are not based onshore, these programs generally can offer greater access to investments and mutual funds which may not be available in the United States because of industry regulatory restrictions. Thus, individuals participating in an Offshore Variable Universal Life Insurance program will have greater flexibility in diversifying their investment portfolio because they will have access to choose securities and funds which are not available domestically. Additionally, because the insurance structure is not subject to the United States insurance regulatory requirements, cost savings will result. 6 Keep Assets Offshore (Asset Protection Considerations) The utilization of an Offshore Variable Universal Life Insurance policy can also provide the benefit of asset protection by keeping certain assets offshore (and potentially away from domestic creditors) under the Offshore Variable Universal Life Insurance policy. Additionally, for individuals concerned with confidentiality considerations, the offshore programs will be able to address those concerns more adeptly than the domestic insurance programs or the traditional domestic investment alternatives. 5 Commissions can sometimes range as high as 50% of first-year premiums paid to fund the insurance policy. 6 Some of these insurance regulatory requirements discourage the appointment of fund managers from these offshore investment funds.

4 All of the above-described benefits can be realized without affecting the existing structure of the foreign trust or the identity of the investment advisor. 7 This Offshore Variable Universal Life Insurance structure not only benefits those involved with foreign grantor trusts, it is also of great help to those involved with foreign non-grantor trusts. This is because after the enactment of the new rules, foreign grantor trusts are treated very similarly to foreign nongrantor trusts. As such, the Offshore Variable Universal Life Insurance structure should be seriously considered by anyone with any type of existing foreign trust. If you have any questions or need additional information, please do not hesitate to contact Rowbotham & Company LLP via phone ( ), fax ( ), or (consult@rowbotham.com). 7 Assuming certain minimum investment thresholds are satisfied.

5 Offshore Variable Universal Life Insurance C COMMENTS Foreign Trust purchases an Offshore Variable Universal Life Insurance policy Insurable life can be the Insured (avoid United States premium excise tax of 1% if insured is a foreign person) of such policy and the Foreign Trust is the Beneficiary of such policy (as such, the Beneficiaries of the Foreign Trust will ultimately receive the death benefit tax-free) As policyholder, the Foreign Trust will make the premium payments to the insurance provider (probably over a period of no less than 5 years so as to ensure liquidity within the insurance policy) Appreciation in the investment account underlying the insurance policy will be totally tax-free (the tax savings of such become more significant as the policy remains in existence) assuming that the insurance policy is not busted-up before the relevant death event The investment account is completely segregated from the corresponding insurance account It is imperative that neither the insured, nor the policyholder, maintain too much control over the investment decisions to be made in the managing of the investment account underlying the insurance policy The Foreign Trust will be able to utilize the investment advisor of their choosing if the amount paid into (as premiums) the policy is greater than a certain threshold amount. This chosen investment advisor would probably be subject to a review to ensure that they are a bona fide investment advisor As policyholder, the Foreign Trust can take loans (at very low interest rates, if not interest-free) out from the investment account (the receipt of these loans by the Foreign Trust would be tax-free pursuant to existing insurance tax rules because the Foreign Trust would in effect be borrowing its own money). These loans do not have to be re-paid until the relevant death event Subsequent to taking out loans from the policy, the Foreign Trust can then make a tax-free distribution (in the amount of the loans) to the Beneficiaries. These would be tax-free distributions since the Foreign Trust would not be generating any income on its own account (thus this would be considered a distribution of corpus) Upon the death of the Insured, the Beneficiaries will receive the death benefit tax-free pursuant to Sec. 101 of the IRC Variations on the structure are very possible (e.g. use of two policies) to suit the needs of particular clients

6 Offshore Variable Universal Life Insurance ADVANTAGES All distributions to the Beneficiaries will be tax-free Investment account grows very rapidly as a result of the tax-free appreciation The costs of entering into an Offshore Variable Universal Life Insurance policy will easily be offset by the savings experienced as a result of the tax-free appreciation (together with the advantages of compounding) Trustee can continue in his present capacity as Trustee of the Foreign Trust The current investment account structure and related investment advisors probably do not have to be altered The Beneficiaries will receive a substantial tax-free death benefit upon the death of the Insured