Planning Ideas with Life Insurance To the Sunset and Beyond

Planning Ideas with Life Insurance To the Sunset and Beyond Dick Kait, JD, LLM, CLU, ChFC PLAG.3326 (09.12)

This presentation contains statements regarding the tax treatment of certain financial assets and transactions. These statements represent only our current understanding of the law in general and are not to be considered legal or tax advice by purchasers. Estate tax rules and the tax treatment of life insurance are subject to change at any time. Neither Protective Life nor its representatives offer legal or tax advice. Purchasers should consult with their legal or tax advisor regarding their individual situations before making any tax-related decisions.

Today s planning environment Planning for middle class Planning for high net worth

Flurry of legislative changes The only thing certain is... change Planning opportunities: o o o o o Family Income Protection Asset Growth Asset Diversification Retirement Wealth Transfers and Legacy Planning

Continuing State of Uncertainty Real world planning ideas for most clients before 2012 Trends and opportunities $5.12 Million exemption clients are considering gifts and loans before 2013 Accelerating gifts to fund life insurance Emphasis on fundamentals and flexibility, since rules can sunset on 1/1/2013

Are these threats our friends? Estate and Gift Tax Exemption, Tax Rates and Portability after 2012? Curbs on GRATs? Dynasty Trusts? Valuation Discounts? Defective Trusts? Will Congress clarify Clawback confusion?

2012: Perfect Storm for Gifting Low property values Historically low AFRs and 7520 rate (the hurdle rate ) Exemptions are expiring President s proposals are looming

President Obama s 2013 Budget Proposal Would reduce Estate and GST Tax Exemptions to $3.5M, and Gift Ta Exemption to $1M, with 45% top rate for those taxes Would continue portability of deceased spouse s unused estate and gift tax exemption

President Obama s 2013 Budget Proposal Eliminate trust GST exemption on the 90 th anniversary of the dynasty trust Eliminate discounts on family-controlled entities Require minimum 10-year term for GRATs

President Obama s 2013 Budget Proposal Modify treatment of grantor trusts so that: Trust assets would be subject to estate tax Distributions to a beneficiary during the grantor s lifetime would be subject to gift tax Trust assets would be subject to gift tax if the trust ceases to be a grantor trust during the grantor s lifetime

President Obama s 2013 Budget Proposal CAUTION: Most ILITs are grantor trusts! The power to use trust income to benefit the grantor s spouse. IRC 766(a)(1) The power to use income to pay premiums on policies insuring the grantor. IRC 677(a)(3) The grantor s non-fiduciary power to substitute trust assets for assets of an equivalent value. IRS 675(4)(C); and Rev. Rul. 2011-28.

Advantages of Lifetime Gifting Removes appreciation and income from donor s estate Gifts to an intentionally-defective grantor trust (IDGT) remove taxes on trust income from the grantor s estate

Advantages of Lifetime Gifting Shifts income to lower tax brackets of donees (except where Kiddie Tax applies) unless IDGT is used Leverages GST exemption, especially via ILITs

Advantages of Lifetime Gifting Removes gift tax from the donor s estate Gift tax is exclusive; estate tax is inclusive IRS 2035(b) adds back to the estate any gift taxes paid within 3 years of death Possible phase-out of valuation discounts Possible return to lower Gift Tax Exemption and higher Gift Tax Rate in 2013

Disadvantages of Lifetime Gifting Loss of control, but this can be mitigated by: Using an FLP or FLLC with the grantor acting as general partner or managing member Voting and non-voting shares Ability to remove and replaces trustees (with someone not related or subordinate to the grantor)

Disadvantages of Lifetime Gifting Loss of stepped-up basis Loss of income Possible clawback

Is Clawback Really a Problem? Congress did not intend clawback, and this intent should override contrary statutory interpretations EGTRRA s sunset provisions treat the $5M unified credit amount as having never existed, once 2013 rolls around Clawback is inconsistent with the entire unified gift and estate tax statutory scheme to tax prior gifts at death that were exempt from tax at time of the gift

Is Clawback Really a Problem? IRS 2001(B)(2) provides that the use of tax rates in effect at the decedent s death applies to the constructive gift tax computation thus, by logical and consistent reasoning unified credit amounts at death should likewise apply. Even if clawback becomes a reality, the potential to pass appreciation on the transferred assets tax free is a powerful impetus for gifting now.

2012 Year-End Gift Strategies

Simple Gifts Forgive personal loans Pay off children s mortgages and college loans Gifts for benefit of dependents education and health Equalize custodial gifts and Section 529 Plans Pay off split-dollar and premium financing Gift non-voting interests in family business or farm Shift ownership to children

Planning Strategies with Life Insurance for Middle Class Households

Concept: Premiums to provide guaranteed income to beneficiaries Family wants to avoid lump sum to survivors Needs solution to replace income in case of breadwinner s death Client buys a policy with a guaranteed income stream death benefit Solution: Income Provider Option (IPO) Rider Income stream + Lump Sum Can calibrate the Lump Sum according to need

Concept: Asset Allocation and Tax Management to protect against potential rising income tax rates in future years Client has concerns due to potential for rising income taxes Expectation: receiving significant ordinary income and capital gains in future years Shift allocation of assets and include permanent life insurance in financial plans Why Now? Possibility of increased state and federal income taxes in years ahead Solution: take steps to mitigate income tax risk through portfolio review

Concept: Gifts to Protect Future Generation Grandparents concerned about the uncertainties facing their grandchildren Clients with young grandchildren who could use financial assistance for life events Gifting premium dollars to help grandchildren to lock in coverage (VUL or CAUL) Access to cash values for college tuition, home purchase, retirement income To memorialize love through the gift of insurance

Concept: Gifts to Protect Future Generation How it works Female 35 with young child Insured s parent gifts $86,270 $86,270 single deposit to guaranteed UL Initial Death Benefit: $1,000,000 Child Term Rider: $20,000/30 years Includes a rider for LTC needs

Concept: Leveraging Concentrated Portfolio Client situation Why Now? Benefits Insurance as asset class Predictability and guarantees De-risk portfolio policy benefits can decoupled from market volatility

Stock Max Married Couple (78M/75F) both Standard NT own portfolio with $1.25M. Average dividend yield of 3%. Cost basis of $750,000 No plan: Grow stock to LE of wife, nets $840,000 to heirs on second death (after estate tax hit). Strategy: Sell stock, pay tax, use after-tax cash to buy Guaranteed SUL with $2.5M Death Benefit to heirs on second death.

Planning Strategies with Insurance: High Net Worth Households

Sophisticated Gifts ILITs, Switching ILITs, Accelerated Gifts Private Split-Dollar Loans Dynasty Trusts Formula Gifts Wandry Spousal Lifetime Access Trusts Intentionally-Defective Grantor Trusts Grantor Retained Annuity Trusts Beneficiary-Defective Inheritor s Trusts Qualified Personal Residence Trusts Private Split-Dollar Loan Regime

ILITs

Switching ILITs Sale of policy from Old ILIT to New ILIT for cash or promissory note If transfer is bona fide sale at Fair Market Value, then the 3-year Look-back Rule (IRC 2503) does not apply No transfer-for-value, if New ILIT is a Grantor Trust. Rev. Rul. 2007-13 No gain on sale, if Old ILIT is a Grantor Trust (or if no gain in policy). Rev. Rul. 2007-14

Concept: Accelerated Gifts into ILIT Stuffing ILITs with all or portion of $5.12M Client wants multi-generational transfer Client wants to use 2012 Gift Exemption Desires insurance policy as part of alternative investment strategy Leverage and arbitrage

Concept: Accelerated Gifts into ILIT How does the ILIT fund the policy? Single Deposit (use large gift to pay premium) Carriers are retreating from sales with large deposits Limiting deposit amounts Withdrawing products Repricing products Trust-owned MEC powerful planning idea for high net worth clients If policy is held to death, no adverse tax impact If withdrawals or policy loans, income taxes and penalties

Concept: Accelerated Gifts into ILIT ILIT- owned policy + IPO Rider Client (76F, STD NT Widow) makes single gift to ILIT $1M ILIT buys guaranteed, no-lapse UL for initial DB $2M Selects the IPO Rider Installments paid out over 20 years to 2 Sons Lump Sum DB paid to ILIT (for benefit of grandchildren).

Concept: Accelerated Gifts into ILIT How does the ILIT fund the policy? Non-MEC level pay Minimum premium funding Max-funding to LE ILIT Side Account (a/k/a Premium Reserve Account) to avoid MEC status Private Premium Financing

Concept: Private Split-Dollar (Loan Regime) Insured loans funds to ILIT, with AFR interest Interest can be gifted (or actually paid back) Funds inside ILIT used to pay premium ILIT owns policy Death benefits paid to ILIT beneficiaries (after loan is repaid, with accrued interest)

Concept: Private Split-Dollar (Loan Regime) Why Loan Regime now? Low interest rates 9-Year Loan (Mid-Term AFR = 0.84% in September 2012) Assets held inside ILIT earn 5% - to 7% Arbitrage trust assets may outperform the hurdle rate Trust Net Earnings used to pay premiums Wait-and-see planning Flexibility Repay Loan, or Forgive loan (make completed gift)

Concept: Dynasty Trust

Concept: Dynasty Trust! "#$ %#$ &#$ '#$ (#$ )#$ *#$ #$

Concept: Dynasty Trusts Advantages Creditor protection Divorce protection Estate tax protection Dispositive plan protection Spendthrift protection Wealth management Consider whether gift should use remaining Gift and GST Exemption Amount

Concept: Reducing Estate Tax Exposure While Retaining Access to Assets SLAT Wealthy client wants to make large gift to ILIT but keep some flexibility to react to changed circumstances Younger clients (35-50) reluctant to make an irreversible wealth transfer before their retirement years SLAT Lifetime access for non-grantor spouse Flexibility for younger, upwardly mobile couple

Reciprocal SLATs If Husband and Wife set up trusts for each other that are similar, then the two trusts may be uncrossed and treated for estate tax purposes as if each spouse had created a trust for himself/herself. United States v. Grace, 395 U.S. 316 (1969). Gift splitting is generally unavailable with SLATs.

Avoiding Reciprocal Trust Doctrine Use different standards e.g., ascertainable standard in one SLAT, and fully-discretionary provisions in the other SLAT. Use different trustees name Wife and Trustee and Beneficiary of one SLAT. Name Husband as Co-Trustee (with independent third party), and beneficiary of the other SLAT.

Avoiding Reciprocal Trust Doctrine Give one spouse a 5%/$5,000 power, but not the other. Give one spouse a limited power of appointment, but not the other. Give one spouse the broadest possible limited power of appointment, and the other spouse a power of appointment limited to grantor s descendants.

Avoiding Reciprocal Trust Doctrine Give one spouse a limited power of appointment both during lifetime and at death and give the other spouse a power only at death. Include a marital deduction savings clause in one trust, but not the other.

Avoiding Reciprocal Trust Doctrine Create trusts at different times. Fund one with liquid assets, and the other will illiquid assets.

Upstream Gift to Parent Client situation Affluent child has ample financial resources to make large gift or loan to parents, enabling parents to develop a solution for their estate liquidity needs Parents lack liquidity, but are under-insured (small business owners and farm families) Adult child makes loan or exemption gift to parents or to parents ILIT for benefit of surviving spouse, children, and/or grandchildren Caution incidents of ownership Consider chronic Illness ( ExtendCare ) Rider

Innovative Gift Idea: Children Gifting to Parents Wealthier child gifts $566,779 to Mother (age 78) to buy $1M guaranteed no-lapse UL policy Guaranteed to Age 105 + LTC Rider Personally-owned or trust-owned? Assume monthly withdrawals of $8,500 LTC Rider starts at Year 8 (when she s 86), continuing through Age 95 If rider benefits are not exercised, IRR at LE (age 92) is 9.2% (pre-tax equivalent) based on guaranteed assumptions

Planning Idea: Minimizing Gift Tax with GRATs Client wants to remove growth in asset values out of taxable estate Has high-yielding or rapidly appreciating assets Transfer assets to GRAT, taking back income stream, with little or no gift tax cost Before possible Congressional curbs on GRATs

Planning Idea: Minimizing Gift Tax with GRAT Diagram of 2-Year GRAT

Reasons for Portability 1. Eliminate the need for spouses to retitle property and create credit shelter trusts 2. Basis step-up at surviving spouse s death 3. Protect against erosion by IRD 4. Preserve spousal rollover

Reasons for Portability 4. Supercharge first decedent s Exemption Amount by having surviving spouse gift that amount to a grantor trust for the descendants 5. Protect against decline in value of the credit shelter trust 6. Deferral of state death tax on the difference between federal and state Exemption Amounts

Reasons for Credit Shelter Trust 1. Property management 2. Transfer of post-death appreciation 3. Protect against decreases in the Exemption Amount 4. Spendthrift protection 5. Creditor protection for surviving spouse 6. Remarriage and blended families

Reasons for Credit Shelter Trust 7. Possible loss of Exemption if surviving spouse remarries and survives a second spouse 8. Use of a state s Exemption by deceased spouse 9. Allocation of first decedent s GST Exemption 10.Surviving spouse can lend money to the Credit Shelter Trust (at AFR) to obtain higher ROI 11.Portability set to expire in 2013

* ExtendCare is not available in California, Connecticut, Florida and New York. Some optional endorsements and riders available at additional cost. Some riders available only at issue. Actual terms and conditions contained in each endorsement and rider govern all benefits provided; assumes medical and financial underwriting qualifications at time of initial application. A portion of periodic payments may be reported as taxable income to the beneficiary. Please see the endorsement for more detailed information. Policy form numbers VUL-12 and UL-15. Rider form numbers UL-E35, L627 8-10 and ICC10-P- R2. Policy and rider form numbers, product features and availability may vary by state. Riders may not be available on all currently-marketed UL products. Consult policy for benefits, riders, limitations, and exclusions. Subject to underwriting. Up to a two-year contestable and suicide period. Benefits adjusted for misstatements of age or sex. In Montana, unisex benefits and rates will apply. All payments and all guarantees are subject to the claims-paying ability of Protective Life Insurance Company. Life Insurance and Variable Universal Life Insurance policies issued by Protective Life Insurance Company (PLICO). Securities offered by Investment Distributors, Inc. (IDI). Both located in Birmingham, AL. IDI is the principal underwriter for registered insurance products issued by PLICO, its affiliate. Investors should carefully consider the investment objectives, risks, charges, and expenses of variable universal life insurance and its underlying investment options before investing. This and other information is contained in the product prospectus and its underlying investment options. Investors should read the prospectuses carefully before investing. Prospectuses may be obtained by calling PLICO at (800) 456-6330.

Thank you. Protective Life Advanced Sales Team Phone: 800-628-6390