Irrevocable Life Insurance Trusts for High Net Worth Families ======= An Actuarial Assessment

Transcription

1 Irrevocable Life Insurance Trusts for High Net Worth Families ======= An Actuarial Assessment Presented by William A. Dreher, F.S.A. Compensation Strategies, Inc. August, 2009

2 Definition of an ILIT Grantor creates trust to be funded by grantor, designating beneficiaries Trustee buys life insurance on grantor or other family members Trustee exercises all policy ownership rights Death benefits distributed to beneficiaries free of income tax liability Death benefits not included in grantor s estate 2

3 Facts & Assumptions for Specimen HNW ILIT Sponsor Husband age 48: life expectancy 34 years Wife age 46: life expectancy 42 years Two children, girl age 15 and boy age 12 Accredited Investor & Qualified Purchaser, per SEC definition Wills provide for full marital transfer Joint life expectancy: 47 years Husband s current insurance: $40MM of variable life insurance Lifetime gift tax credit already used: $600K Life reinsurance market limit: $65MM 3

4 Why & Why Not to Create an ILIT? Why? Estate taxes unlikely to disappear Avoids estate taxes on substantial $s Why not? Ultimate benefit deferred until second death Limited appeal to beneficiaries Many more tangible uses of gift tax exemptions Starter homes for children Capital for child s new business venture Supplement a yuppies early career income Fund educations of grandchildren 4

5 Critical Factors Affecting an ILIT s Design Overriding design criterion: Avoid gift taxes Choosing the insured(s) Early year vs. spread funding By direct gift or by loans For loan financing: Alternative Federal Rate Policy type: individual or survivor life Life reinsurance market limits 5

6 Funding the ILIT with Gifts Gifting options: Full funding in early years More efficient use of lifetime gift tax credit Matching annual premium requirements Minimizes annual cash flow Inferior to financing with loans Must satisfy IRS present interest test 6

7 Funding the ILIT with Loans Grantor loans to trust match premium pattern of life insurance policy Loan agreement specifies interest rate. Typically, AFR at outset Applies to entire term of loan Grantor pays trust loan interest when due. Trustee returns to grantor interest due on loan. Wash transaction for both cash flow and income tax Grantor s payment tested for gift tax liability against Annual gift tax allowances Unused lifetime credit Loan repaid at death from life insurance proceeds Reduces $ for $ amount escaping estate tax Option to accumulate interest payments until death 7

8 Illustration of Gifting: Maximum $s of Life insurance Design: Extension of husband s variable life policy Premiums heaped in first five years $335K per year Assumed annual return on variable life cash value 8 % 10% Results: Initial death benefit: $6.1MM Death benefit at husband s LE (8%): $15.6MM Death benefit at husband s LE (10%): $31.4MM 8

9 Impact of Alternative Federal Rate on ILIT s Design & Cost AFR selection drives Maximum initial death benefit Loans by grantor Illustrations that avoid gift taxes: Assumed AFR = 3.7%; Initial death benefit = $13.4MM; Grantor loans = $3.7MM Assumed AFR = 5.0%; Initial death benefit = $9.9MM; Grantor loans = $2.7MM What if future AFR is underestimated? Suppose initial death benefit is $13.4MM & average AFR proves to be 5.0% Result: $960K of taxable gifts 9

10 Design Alternatives with Universal Life & Level Annual Premiums Annual premium for 34 years = $123K Max. premium for $0 gift tax on SUL policy Examples: Insure wife; level death benefit Result = $18.9MM Insure wife; increasing death benefit Initial death benefit: $8.4MM Death age 89 (her LE): $24.0MM Insure both; level death benefit First 4 years: $54.4MM After 4 years: $24.4MM DB in 1 st 4 years = bonus protection for risk of mutual death 10

11 Variable Life Insurance: The Optimal Solution Survivor life is best fit with anticipated estate tax due date Variable life permits investment in equities Make sense when expected payment on death is 47 years away Husband s current policy meets insurer s minimum premium requirement Standing alone, ILIT premiums would not qualify Initial death benefit capped at $25MM due to reinsurance limits Ultimate death benefit depends on investment performance: In 47 th year (joint LE) with 8.0% ROR%, death benefit = $31.9MM In 47 th year (joint LE) with 10.0% ROR%, death benefit = $89.8MM 11

12 Loan Financing: With Loan Interest Accumulation Design & investment assumptions Husband insured 5 premiums of $548K Investment return: 8.0% AFR: 5.0%; CPI: 3.0% Initial death benefit: $9.7MM Result Death LE: $25.6MM Loan + accumulated LE: $13.1MM Undermines ILIT s objective: 51% of death benefit subject to estate tax 12