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September 20 2021

Now is the Time for Key Person Coverage

Situation: A financial professional contacted DBS’s in-house advanced case design resource to brainstorm when to approach business prospects that had expressed an interest in discussing supplemental executive benefit arrangements for key employees. Prior to COVID-19, the financial professional ran a successful telemarketing campaign focusing on mid-sized corporations. The campaign specifically promoted executive benefit arrangements that can be established on a discriminatory basis to help supplement retirement income for key executives. The financial professional was in the process of meeting with the business owners when COVID-19 caused most states to institute stay-at-home orders.

Problem: The financial professional wanted to know if it was too early to reconnect with the businesses now that states were beginning to permit businesses to open.

Solution: The DBS advanced case design resource described how it is likely that most business owners were adversely impacted and experienced revenue loss as a result of COVID-19. She suggested that business owners are likely still concerned that COVID could continue to negatively impact revenue since the Delta variant is showing that the pandemic is not over. Therefore, at the present time, businesses may be reluctant to proceed with an arrangement requiring a long-term commitment. However, they likely recognize the current precarious business situation and how the death of a key person at this time could result in permanent business closure.

The DBS associate suggested a two-phase approach. In phase one she suggested that a term policy on a key person with the business as an owner and beneficiary to help protect the business against loss caused by an untimely death. She noted that acquiring the coverage is relatively easy and inexpensive. The executive insured as a key person may be the same individual the business owner initially desired to help with supplemental retirement income. By underwriting the executive for key person coverage first, the financial professional will be in a better position to proceed with the executive benefit arrangement when there is less economic uncertainty.

Result: The financial professional liked the two-step approach and proceeded to begin reconnecting with the business owners.

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September 13 2021

Own Your Own Policy Buy-Sell

Nearly all buy-sell agreements that use life insurance have one thing in common: The business owners do not own the life insurance policies that insure their own lives. In an entity purchase arrangement, the business owns the policy. In a cross-purchase arrangement, the other owners or another entity own the policies.

Common Concerns Expressed by Business Owners

Many buy-sell agreements are triggered when an owner retires, becomes disabled or voluntarily leaves the business. In these cases, the death benefit cannot be used to purchase the departing owner’s interest. Yet, the departing owner’s policy may be a valuable asset that could be used for the departing owner’s financial plans. The fact that the business owner does not own his/her policy has the potential to raise the following concerns:

1. If the owner’s health deteriorates, he may become uninsurable and unable to purchase other coverage to meet
his/her family needs.
2. Even if the insured is insurable, the cost of purchasing new life insurance coverage could be prohibitive.
3. Of course, during the term of the buy-sell arrangement, the business owner is precluded from making decisions about the policy insuring his/her life.

Because of these concerns, it’s not unusual to find many buy-sell agreements funded with a term insurance policy. In contrast, when the business owner owns his/her policy, the owner has more reason to consider a permanent policy.

How the Own-Your-Own Policy Buy-Sell Structure Work

With this approach, the owners enter into a cross-purchase agreement where each owner agrees to purchase their pro rata share of the other business owner’s interest. However, instead of each business owner purchasing a policy on the other owner’s life, each business owner purchases and owns a life insurance policy on his/her life. The policy’s value will be based on at least his or her proportionate projected value in the business. The arrangement is structured as a non-equity endorsement split-dollar agreement (normally using a return of premium death benefit option) with the death benefit endorsed to the other business owners to satisfy the obligation under the buy-sell agreement. The necessary endorsement forms are filed with the insurance carrier.

At an insured business owner’s death, the death benefit is paid to the surviving owners according to the terms endorsed, and each surviving owner uses his share of the death benefit to purchase the deceased’s business interest from the estate as required under the terms of the buy-sell agreement. If alternatively, the business owner retires or otherwise leaves the business, the remaining owners release the endorsement on the departing owner and the departing owner releases his/her interest in the remaining owners’ policies.

How Can DBS Help?

The greatest benefit of this structure is that it gives the business owner control over his/her policy, including the ability to increase the premium level to use the policy for supplemental retirement income. However, the structure does not work in all business structures and raises some tax issues which, with planning, can be avoided. To help you with the design of the own-your-own policy structure, call Terri Getman, JD*, CLU, ChFC, RICP, AEP (Distinguished), DBS’s in-house advanced case design resource.

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September 3 2021

Business Uses Of Life Insurance

There are six key ways in which life insurance may benefit your business

Business Transfer: Businesses or business owners can execute a buy-sell agreement and fund it with life insurance. A buy-sell agreement is an arrangement for a business to continue in the event of the owner’s death, disability, retirement or early withdrawal from the business. Life insurance, through the death benefit or cash values (if a permanent policy is used), can help provide the funds for the surviving business or new owner(s) to purchase the business interest.
Key Employee Protection: The loss of a key employee can severely affect the financial health of a business in several ways: lost sales, costs of recruiting and training a replacement, costs to continue the salary to the employee or the family, or loss of credit. Life insurance can provide the business with funds to temporarily replace lost profits as a result of a key employee’s death, strengthen the business’s working capital, and provide funds that may be used to recruit and train a suitable replacement.
Non-Qualified Deferred Compensation (NQDQ) Plans: NQDC plans funded with life insurance can help attract and retain key employees. Such plans are contracts between employers and key employees to pay future compensation for work performed now. Most NQDC plans provide for a stream of payments to be made to the employee following retirement. The payments typically come from the cash value of a permanent (rather than term) life insurance policy. The employee is not taxed on the money until it is received.
Executive Bonus Plans: Another way to provide an extra benefit to key employees is through an executive bonus plan. With this plan, the employer gives a bonus to a key employee who then pays taxes on the money and uses the remainder to purchase a life insurance policy. The employee has all ownership rights in the policy, such as access to the cash value and the power to designate beneficiaries, while the employer receives a tax deduction for the bonus.
Supplemental Executive Retirement Plans (SERPs): SERPs provide key employees with supplemental retirement income generated by the cash value of a life insurance policy. Qualified defined contribution plans are limited to considering only the first $230,000 of compensation when arranging retirement benefits for highly compensated employees ($245,000 in 2009). SERPs layer in on top of such defined contribution plans, giving key employees a more robust total retirement plan package.
Debt Coverage: Life insurance proceeds can provide a business with funds to help pay off business debts in the event of the owner’s premature death. A life insurance policy is taken out on the life of the owner when the debt is first incurred.

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August 20 2021

The $12 Trillion Opportunity

Situation: According to LIMRA’s 2021 Insurance Barometer study1, 40% of Americans live with a life insurance need-gap. This equates to 102 million adult consumers. This shows the consumer demand or “need” for coverage has increased and remains strong. The gap between “I need” and “I have” life insurance has doubled since 2019, further emphasizing the need for advisors to respond to the existing demand.

The pandemic has driven an increase in purchase intent. 31% indicated they are more likely to buy life insurance due to COVID. Furthermore, the percent of respondents indicating an increased likelihood to buy increases with income: 42% of respondents with incomes of $150K+ indicated they were more likely to buy due to COVID. This is strongest among Millennials, Gen Xers, Black, and Hispanic respondents.

Bottom line: LIMRA estimates the total market coverage gap at $12 trillion.

If there is a silver lining to these dismal statistics, it is that according to LIMRA, approximately 60 million households recognize that they need more life insurance. So why don’t they buy?

One obstacle is that advisors are not talking about life insurance. According to LIMRA, many households who believe they need life insurance say the reason they haven’t purchased is because they haven’t been approached by a financial advisor. Almost 8 in 10 U.S. households admit they do not have a personal life insurance agent to turn to and most say they never did. In fact, many financial advisors don’t talk about life insurance, even if the client brings it up! No wonder we find ourselves in such a sorry state!

Solution: A financial advisor can build a plan whose sole design is to accumulate dollars toward every goal a client has. It can be creative, tax-efficient, and even leave the client with a comfortable lifestyle as they save toward their life goals. But what happens if the client dies prior to achieving his/her investment goals? The best investment plan in the world isn’t worth much if it doesn’t take this risk into account. That is why life insurance is generally considered the backbone of a financial plan. Neglecting to include this can actually make an advisor vulnerable to a lawsuit, especially if they are holding themselves out as a fiduciary.

Unfortunately, the rise of easy money in the mutual fund business displaced life insurance sales as the way to make money. Today it is about money under management.

Life insurance is the “ugly duckling” of the financial service industry. Consequently, no one wants to talk about it.

Talking about life insurance is hard because it involves a very personal discussion. It is different from investment products that benefit the purchaser. Life insurance benefits others when the purchaser is no longer there. This discussion touches emotional nerves for the buyer and seller, so it can be tough to even initiate the discussion. So, how do you transition from an investment conversation to a life insurance discussion? Here’s a suggestion:

TRY THIS

“Up until this point, most of our conversations have focused on minimizing portfolio risks to help you reach specific financial goals, so we’ve talked about things like diversification and asset allocation. It is also important to spend a little time addressing risks that can prevent you from reaching those goals. As you age, one of three things will likely happen: you’ll die too soon, get sick along the way, or live too long. Insurance is key to protecting yourself and your important family goals at each of these stages. To help me generally determine the types of life insurance you may need, I just need to ask you: do you want your life insurance to provide protection if you die or when you die, or both? If you can give me a few minutes, this suitability fact finder can help us determine the amount and type of life insurance you should have. ”

Here are some questions to get you started:

Have you ever wondered how long you could afford to live on your savings? That’s the deal you’re leaving your family if you have no or little life insurance. Asking this question reminds people of the realities of life and that may be all it takes to answer this difficult personal question.
How important is it that your family continue to live in the world you created, even if you are not here? Sometimes you just need to ask the hard question. Again, asking this question reminds people of the realities of life, and that may be all it takes to answer this difficult personal question.
Do you know anyone whose family circumstances deteriorated after the death of a parent? It seems there are so many stories just like this. Maybe a little somber, but it’s a way to get prospects to think. Life insurance allows your clients to grieve without financial pressure.
What plans have you made for the orderly transition of your business if you can’t stay involved anymore? This question can get the business succession discussion started for your business owner client.
Do you know if your life insurance will last as long as you will? Have you outlived your temporary life insurance solutions yet? Another great question for a client with existing life insurance. Many clients purchase term insurance when they are in their 30s and 40s, falling for one of the great lies we tell ourselves, “By the time I’m in my 60s I’ll have so much money I won’t need any life insurance.” However, divorces, second families, rampant consumerism, and long-term care expense concerns have changed all of that.
Has anyone reviewed your life insurance portfolio lately? Since people aren’t talking about life insurance as much anymore, life insurance policy reviews are rarely discussed. Helping your client understand the value of their existing coverage, regardless of where it is and from whom, gets them thinking the right way about what they really want and should do today.
Do you know the determining factor of whether you can buy life insurance? Most people think that if they have enough cash, they have access to buy all the life insurance they might want. Of course, that’s not true. A client’s health buys it. Money only pays for it.
Have you insured your most valuable asset? Most people will point to their house, but earning power is actually the most valuable asset. Insure a person’s earning power and you’ve insured their lifestyle.
If you were selling your business and I were buying, how big of a check would I have to write to convince you to leave? This amount is not likely what the business is worth, but a good way to open the door to getting an informal business valuation which can lead to a discussion of using life insurance to help fund a buy-sell arrangement.
What do you want your life insurance to do for you? Is yours doing it? A recent study found that most people didn’t believe that their life insurance is doing what they wanted it to do. Therefore, this question can be asked with confidence knowing that you have a good chance of getting into the discussion of their existing life insurance and opening an opportunity for a policy review.

In Summary: It is ironic – and unfortunate – that life insurance is usually not on the ‘front burner’ when people review their financial affairs. Investment products and retirement plans get far more interest and attention than life insurance, yet these financial products can take decades to reach the point where they begin to fulfill their purpose. The sad truth is, many people run out of time and die too soon before plans are complete.

No accumulation plan can solve the problem of premature death. Only life insurance can provide funds when ‘people at work’ is no longer an option. Life insurance proceeds can help replace lost income to make mortgage payments, cover living expenses, and pay bills. Only life insurance can provide the funds when ‘money at work’ is an unrealized dream cut short by premature death. Life insurance proceeds can help provide funds to pay tuition bills, fund buy-sell arrangements, equalize inheritances and provide the liquidity to pay estate taxes. Only life insurance can help rescue a business, the jobs of its employees, and the lives of the owner’s family if the business owner, in the words of Ben Feldman, “walks out the door in the morning and never comes back.” No one needs to buy life insurance, but as financial advisors at the end of the day, we need to ask ourselves: can we honestly say that we have taken care of our clients if we have not asked about this important financial product?

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August 6 2021

2021 Life Insurance Barometer Study Results

The annual Insurance Barometer Study tracks the perceptions, attitudes, and behaviors of adult consumers related to financial behaviors, with a focus on life insurance. This year, just 52 percent of Americans report having life insurance coverage, which means the opportunity for YOU is growing. Take a look at the rest of the results and arm yourself with the facts as we head into September’s Life Insurance Awareness Month – the perfect time to talk with your clients about their life insurance needs!

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July 30 2021

Raising Interest Rates and Legacy Planning

Situation

Interest rates factor into the performance of many legacy and charitable planning techniques. So, over the past several years, the historically low interest rates, and the availability of higher gift and estate exemptions have provided a unique environment for certain legacy and charitable planning techniques. Specifically, in a low interest rate environment grantor retained annuity trusts (GRATs), charitable lead annuity trusts (CLATs), intra-family loans and installment sales to grantor trusts work best. However, relatively small shifts in interest rates can have a disproportionate effect on the performance of these rate-sensitive legacy planning techniques. Increases in interest rates could change the economics and shift the focus to other techniques.
If interest rates start to increase, there may be renewed interest in certain legacy and charitable planning strategies that benefit from a higher rate environment. Techniques that benefit from a higher interest rate environment include qualified personal residence trusts (QPRTs) and charitable remainder annuity trusts (CRATs). After several years of keeping interest rates low, the Federal Reserve may consider raising interest rates. This Counselor’s Corner describes some of the legacy planning techniques impacted by interest rates and the role of life insurance.

Solution

Before describing some of the most common planning techniques impacted by interest rates, we need to understand the rates used by the strategies. Two federally-set interest rates directly impact legacy planning: applicable federal rate (AFR) and §7520 rate.

Each month, the Internal Revenue Service publishes short, mid, and long-term AFR and §7520 rates. All the rates are calculated based on the yields of certain government debt obligations. Short-term AFR rates are determined from the one-month average of the market yields from marketable obligations such as U.S. government T-bills with maturities of three years or less. Mid-term AFR rates are from obligations of maturities of more than three years and up to nine years. Long-term AFR rates are from bonds with maturities of more than nine years. The §7520 rate is fixed at 120% of the annual mid-term AFR for the month in which the valuation date falls.

Applicable Federal Rate is the minimum interest rate that can be charged for loans between related parties.
The §7520 rate is the rate used to calculate annual payments on such planning strategies as GRATs, CLTs, CRTs, and QPRTs.

Strategies for A Low Interest Rate Environment

If interest rates start to go up, clients will want to look into techniques that work best in a low interest rate environment. At their core, these techniques involve lending strategies that leverage the low interest rates to transfer the appreciation on assets to younger family members at little or no gift tax.
The federally-set interest rate reflects the hurdle that the asset’s growth must exceed before the strategy will work to transfer value to the younger family members. These techniques enable senior family members to “freeze” the value of the assets that they lend for estate tax purposes while passing the asset’s appreciation over the interest rate hurdle to younger family members. The lower the federally-set interest rate, the greater the likelihood that some appreciation will be transferred to the younger generation as well as the lower the interest paid to the grantor (that is ultimately included in the grantor’s estate).

Techniques used in a low interest rate environment will appeal to clients with the following profile:

Clients who have exhausted their exemption or who wish to preserve their exemption for the transfer of other assets.
Clients who desire to obtain a basis step-up on assets at death.
Clients who desire to retain an income stream from the transferred assets.
Clients nervous about parting with wealth.

Techniques used in a low interest rate environment include the following:
Intra-Family Loans & Installment Sales to an Intentionally Defective Grantor Trust. These two planning techniques will work when the asset growth exceeds the AFR.
1. Intra-family loans

The simplest way to plan in a low interest rate environment is for the wealthy client (lender) to make a cash loan to a younger family member (borrower) whom the client desires to benefit from. The loan can be structured as an interest-only loan with a balloon payment on maturity. To the extent that the borrower on the loan earns a rate of return exceeding the AFR, the lender will successfully transfer wealth.
2. Installment sales to an intentionally defective grantor trust

This transaction is like an intra-family loan, except with this technique, the borrower is a trust created by the wealthy client. Specifically, the trust is an irrevocable grantor trust that’s established by the wealthy client/lender. With this technique, the wealthy client sells an asset to his/her grantor trust in return for an installment note at an interest rate equal to the AFR. Like the intra-family loan, this note back to the grantor can be structured as an interest-only loan with a balloon payment on maturity. Since the trust is a grantor trust, the sale between the wealthy client and the trust is not recognized for tax purposes. Furthermore, as a grantor trust, the wealthy client is required to pay the tax earned on the assets in the trust. As a result, the assets inside the trust grow income taxfree. To the extent the assets in the trust grow at a rate exceeding the AFR, the excess appreciation accrues to the trust beneficiaries free of gift tax.
GRATs & CLATs. These two techniques will work when the asset’s growth exceeds the §7520 rate.

3. Grantor retained annuity trusts (GRATs)

With a GRAT, the wealthy family member (grantor) funds an irrevocable trust that pays the grantor an annuity income for a fixed period that’s established by the grantor. This transaction is like the installment sale, except the payments to the grantor cannot be interest only (must include principal and interest) and the interest rate is the §7520 rate, which is higher than the short and mid-term AFRs. At the end of the trust term, the value remaining in the trust passes to the designated trust beneficiaries. If the trust earns a rate of return exceeding the §7520 rate, the excess amount accrues to the trust beneficiaries. However, the economic benefits of this www.dbs-lifemark.com 5501 Excelsior Boulevard | Minneapolis, MN 55416 For the Education of Financial Advisors & Financial Professionals. Not for use with the General Public. strategy are often not as great as the sale to the intentionally defective grantor trust since the annuity payment to the grantor includes principle and is often at a higher interest rate. Individuals often create a series of short-term rolling GRATs rather than a single long-term GRAT. Often the short term GRATs are structured as “zeroed-out GRATs.” This means that the present value of the annuity payment, based on the §7520 rate, equals the fair market value of the assets contributed to the GRAT. Because of this, there should not be a taxable gift.

4. Charitable lead annuity trusts (CLATs)

This transaction is like a GRAT, except a charity, not the grantor, receives the annuity income payment. Funding the CLAT (structured as a grantor trust) can give the grantor an immediate charitable income tax deduction. However, in future years, the income paid to the charity is taxable to the grantor. This technique tends to be appealing to taxpayers with a spike in income for a single year. Of course, the ability to take the full charitable deduction for the amount contributed to the grantor CLAT is subject to the various percentage and other limitations and requirements imposed on charitable income tax deductions. Any unused deduction can be carried forward for up to five years.

Unlike GRATs, CLATs can choose to use the §7520 rate in the month of creation or the rate from one of the prior two months. CLATs can also be structured as a non-grantor trust for income tax purposes. In this case, the grantor does not receive an income tax deduction for the contribution to the CLAT and is also not taxed on the trust income. Rather, the CLAT reports the taxable income and receives the charitable deduction.

Role of Life Insurance
The above strategies are typically referred to as “estate freeze” techniques. When successful, they remove the appreciation on an asset from the estate, thus freezing an estate at its current value. So, where the client has a taxable estate prior to implementing the strategy s/he will continue to have a taxable estate – thus a continuing need for life insurance for estate liquidity. Furthermore, since the success of estate freeze strategies is closely linked to a client’s life expectancy, life insurance can serve as protection if an unexpected early death occurs.

Proposed Legislation
Two bills introduced in March 2021 could significantly change the impact of several estate planning techniques if enacted into law. Specifically, the 99.5% Act and the Sensible Taxation and Equity Promotion (STEP) Act would dramatically alter the effectiveness of GRATs and Sales to Intentionally Defective Grantor Trusts. One proposal would reduce the effectiveness of GRATs by requiring a 10-year minimum period and minimum 25% remainder value, thereby prohibiting the use of the popular “zeroed-out GRAT” technique. Another proposal seeks to include grantor trusts as part of a grantor’s taxable estate, thereby negatively impacting sales to grantor trusts.

Strategies for A High Interest Rate Environment – Over the past several years, planning techniques such as QPRTs and CRATs have:

1. Qualified personal residence trusts (QPRTs)

With a QPRT technique, a wealthy grantor transfers a personal residence (principal or vacation) to a trust which benefits the grantor for a period of years. At the end of the term, it passes to the remainder beneficiary. So, a QPRT is like a GRAT in that the grantor retains an interest in the trust. During the term of years, the grantor may continue to use the residence as his or her own. If the grantor wants to continue to live in the home after the period of years ends, the trust or the beneficiaries can rent it to the grantor. The initial transfer of the residence to the trust is a taxable gift of the remainder interest calculated using the applicable §7520 rate. The www.dbs-lifemark.com 5501 Excelsior Boulevard | Minneapolis, MN 55416 This material has been prepared to assist our licensed financial professionals and clients’ advisors. It is designed to provide general information in regard to the subject matter covered. It should be used with the understanding that we are not rendering legal, accounting or tax advice. Such services must be provided by the client’s own advisors. Accordingly, any information in this document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal Revenue Code. For the Education of Financial Advisors & Financial Professionals. Not for use with the General Public. * Not in the practice of law higher the rate, the higher the grantor’s retained right to use the residence and the lower the remainder interest. So, as the §7520 rates rise, the taxable gift of the remainder decreases. At the end of the grantor’s retained period, the residence passes without additional gift tax and is removed from the grantor’s estate.

2. Charitable remainder annuity trusts (CRATs)

A CRAT is the reverse of a CLAT in that the grantor receives the annuity income stream in a CRAT. With a lifetime CRAT, a grantor creates and funds an irrevocable trust which distributes a stated annual annuity amount to specific non-charitable beneficiaries, which can include the grantor and grantor’s spouse. The annuity amount is typically a stated percentage of the trust value which must be at least 5%, but not more than 50%. The annuity income may be paid for: (1) the lifetimes of the noncharitable beneficiaries; (2) a term of up to 20 years; or (3) the shorter or longer of these time periods. At the end of the period, the remainder passes to one or more charities, private foundations, donor advised funds, etc. To qualify, the charitable remainder interest must be equal to at least 10%.

As a tax-exempt trust, if the CRAT is funded with appreciated assets that are subsequently sold, the CRAT will not recognize taxable income/gain. However, the non-charitable beneficiaries will incur income tax on the subsequent CRAT distributions. Furthermore, with a lifetime CRAT, the grantor may obtain a charitable income and gift tax deduction which are determined using the §7520 rate. A higher §7520 rate provides a greater discount in calculating the present value of the annuity income interest received by the non-charitable beneficiaries, thereby increasing the value for the charitable remainder interest and generating a larger charitable deduction. Of course, the ability to take the full charitable deduction for the amount contributed to the grantor CLAT is subject to the various percentage and other limitations and requirements imposed on charitable income tax deductions. Any unused deduction can be carried forward for up to five years.

Role of Life Insurance
Life insurance may be suggested in tandem with a charitable remainder trust. With this strategy, life insurance is used to make the family whole by replacing the value of assets donated to charity with the proceeds of a life insurance policy.

Proposed Legislation
The proposed legislation also negatively impacts CRATs. Under one proposal, transfer of appreciated assets would result in realization of the built-in gain in proportion to the non-charitable beneficiaries’ interest. So, if 90% of the trust benefits non-charitable beneficiaries, 90% of the built-in gain is recognized at the time the trust is funded.

In Summary
Over the past several years of historic low interest rates, planning techniques such as GRATs and intra-family loans have been extremely popular. These techniques are especially prevalent today because of concerns that they will become less effective in the future if some of the proposed legislation is enacted.

July 23 2021

Where a Child Desires Long-Term Care Coverage on a Parent

We’re focusing this month on Life Insurance and Family, with a special focus on generational planning. A recent case shows how the DBS team works for YOU to create solutions!

Situation: An adult child desired to purchase a life insurance policy with a longterm care or chronic illness feature on his elderly mother to help address long-term care concerns. The child recognized that he could be held responsible for expenses incurred by his mother under the Filial laws, and he wanted to protect against this risk. The adult child wanted to be the policy owner and beneficiary since he was paying the premiums.

Problem: The carrier approved the face amount requested but did not want the child as the owner. The carrier would only approve the coverage with the insured or the insured’s trust as the owner.

Solution: The DBS advanced case design resource explained that two problems are often encountered when purchasing coverage on insureds who are retired and who desire coverage primarily to cover potential long-term care costs. First, the face amount is often very small because carriers typically limit coverage to a multiple of “earned” income which does not include Social Security or pension/investment distributions. The second problem, as illustrated in this case, is that it’s not unusual that a child is paying the premium and as such wants to own the policy to make sure the policy is used for its intended purpose.

Proposal: DBS’s advanced case design resource suggested that the desired control could be achieved by putting a collateral assignment on the policy owned by the parent. With a collateral assignment, rights to the policy require consent of both parties. According to the carrier, even if the insured met the 2 of 6 ADLs to qualify for long-term care payment, the decision whether to accelerate the death benefit required consent of both parties. Furthermore, the carrier of this indemnity style product indicated that it would pay the benefits equal to the assigned amount first to the child. The child could use the amounts as he pleased, including as a payment of medical benefits which are not treated as a gift under the current tax law. Result: While the client was not crazy about the option it was better than going to the expense of establishing a trust to own the policy.

Our team of talented Case Design Analysts will work with you to find solutions for your clients. They have the in-depth knowledge of all our carriers and products, and they’re able to dig deeper into the situation to find a solution that may not have been apparent at first glance.

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July 16 2021

A Million to a Billion, in Three Generations…Tax Free

The Generation Skipping Transfer Tax (GST tax) is an extra tax on gifts or bequests from grandparents to grandchildren (or lower generations) that would otherwise skip successive gift or estate taxation. The GST tax rate is a flat 40% regardless of the amount of the transfer or the donor/testator’s gift or estate tax bracket. The combination of gift/estate tax and GST tax can be confiscatory.

Assume that a wealthy grandmother who is in a 40% gift tax bracket and has used up her GST exemption makes an outright gift of $1,000,000 to her grandchild. The total taxes are $960,000 as follows:

Gift tax: $400,000
GST tax: +400,000
Gift tax on GST tax: +160,000
Total taxes: 960,000

That’s right, there’s a gift tax on the GST tax as it is considered an additional gift to the grandchild. Thus, the taxes are 96% of the gift. It takes $1,960,000 to make a gift of $1,000,000.

The taxes are even worse if the grandmother waits until she dies to bequest the $1,000,000 to the grandchild; the taxes total $1,333,333 so it takes $2,333,333 to net the full $1,000,000 to the grandchild. Follow the steps:

Start with $2,333,333
Estate tax at 40% – $933,999
That leaves $1,400,000
GST tax: – $400,000
Net to grandchildren $1,000,000 The combined tax rate is 57%

Direct Skips, Distributions, and Terminations

The above were examples of direct skips: gifts or bequests directly to grandchildren. In direct skips, the transferor (grandparent) pays the GST tax. A direct skip can also be in trust.

E.G. A grandparent gifts $1,000,000 to a trust to provide income to a grandchild for a period of years with the distribution of the principal delayed until the grandchild reaches a certain age, or dies. This is a direct skip and the grandparent pays the GST tax upfront.

Similarly, a trust set up during life or at death to provide income to grandchildren, then income to great grandchildren, etc., is a direct skip and the taxes are paid upfront. But, if “non-skip” persons, such as children, are intervening beneficiaries, the GST tax is not paid until there is a taxable distribution or termination.

E.G. A grandfather sets up a trust that provides income to his children for life, with the principal to his grandchildren at the death of the children. The GST tax is paid when his children die and the principal is distributed to the grandchildren. This is a taxable termination and the grandchildren pay the GST tax.

Distributions of principal or income to the grandchildren while the children are living are GST taxable distributions. The trustee pays the GST tax and, like a direct skip, the GST tax itself is treated as an additional distribution to the grandchildren. Distributions to children are not subject to the GST.

Assignment of Generations and Predeceased Child Exception

The GST tax does not apply to gifts or bequests to “non-skip” persons. It only applies to transfers to “skip” persons, or those who are two or more generations below the transferor: grandchildren or later generations. Individuals who are not related by blood or adoption to the transferor are assigned generations based on their date of birth compared to the transferor. Persons born within 12 ½ years of the transferor are the same generation as the transferor; those born between 12 ½ and 37 ½ years are one generation removed, and therefore not a “skip” persons. Persons born more than 37 ½ years after the transferor are “skips”.

If a parent predeceases his/her children, the children move up a generation.

E.G. A gift by a grandparent to a grandchild is not subject to the GST if the child’s parent, the son or daughter of the transferor grandparent, has predeceased. Similarly, if a grandparent makes gifts to a trust that provides income to a child and principal to grandchildren, trust income or principal that is distributed to the grandchildren is subject to the GST. But, gifts by the grandparent to the trust after the parent-child dies meet the predeceased parent exception the GST

GST Exemption, Allocation and Exclusions

Each transferor (grandparent) has a $11,700,000 GST exemption. Thus grandparents have $23,400,000 in total. Like the regular gift/estate tax exemption ($11,700,000), the GST exemption is automatically applied to direct skips during life or at death so there is no need to elect to use the exemption on the gift/estate tax return. But, election or allocation of the GST exemption is more important with gifts in a trust where the GST tax will be applied upon distribution or termination, rather than upfront as with a direct skip. The amount of the GST tax on taxable terminations or distributions is based on a formula to determine the “inclusion ratio” or percent of the distribution to which the 40% tax rate applies. The numerator for the “inclusion ratio” is the exemption amount allocated to the transfer and the denominator is the total amount of the transfer.

E.G. If a grandparent gifts $20,00,000 to a GST trust, the ratio is 58.5% ($11,700,000/$20,000,000). The inclusion ratio is the reciprocal or 41.5% (1-.585). Later, when a taxable distribution or termination is made, the GST tax will be 16.6% (41.5% x 40%) on the amount distributed.

Early allocation of the GST exemption is very important with life insurance funded trusts. The transferor should make the allocation with each gift on the gift tax form 709. Late allocations can be made by the transferor, even by the executor after the transferor’s death, but the value of the property at the time of the allocation will be used rather than the value when transferred. With life insurance, this means the proceeds will be used as the late allocation value at the transferor insured’s death rather than the premiums which could have been used earlier.

There is also a $15,000 annual exclusion ($30,000 by spouses) for GST gifts. Unlike the gift tax annual exclusion, the GST exclusion does not apply to typical “Crummey” trust provisions. It only applies to outright gifts or gifts to “vested” trusts where the trust funds will be included in the beneficiary’s estate. Thus, the annual exclusion is not used in Dynasty or generation skipping trusts.

Dynasty Trusts and Perpetuities

A Dynasty trust is just another term describing a generation skipping trust. However, it implies something that will last for generations to come. Historically, a trust can only last for as long as “lives in being and 21 years thereafter” (the rule against perpetuities). Thus, you could set up a trust to last for as long as any of your grandchildren or great-grandchildren live, as long as they are alive when you set up the trust. Many states have eliminated the “rule against perpetuities” and a trust can theoretically last forever (AK, DE, ID, SD, WI).

While the Dynasty trust trustee has the usual discretionary powers to distribute income and principal to the beneficiaries, it would be counterproductive to distribute principal as that would be included in the beneficiaries’ estate. Therefore, to enhance the purpose of long-term generation skipping, the trustee often has the discretion to purchase homes or businesses for the use of the beneficiaries thereby retaining asset ownership in the trust.

Life Insurance Leverage and Options

Practically any assets can be put into a Dynasty trust, but it makes sense to get the biggest bang for your buck with assets that will go up in value and will not generate taxable income or capital gains tax. Therefore, the tax advantages and leverage of life insurance may be the magic mover of Dynasty trusts.

E.G. On a product with a death benefit guarantee, a single premium of $2,000,000 used to purchase a policy on a female age 65 preferred non-smoker designed to minimize initial face amount could purchase of policy of slightly more than $2,650,000.* By age 85 the policy would have a death benefit of approximately $6,275,000 at a 7% gross (6.18% net) assumed rate of return. That’s a lot of tax free cash paid to the trust at death that could be invested by the trustee for the benefit of children, grandchildren or generations to come. Sure, they could invest the $2,000,000 in some other way rather than buying life insurance, but will that other investment accumulate, net after taxes, to the same amount as the insurance proceeds? Furthermore, the benefit of income tax-free death benefit could become greater if President Biden’s tax proposals eliminating step-up in basis become law.

The insurance does not have to be on the grandparent-donors. The insurance could be on the children to enhance the benefit for grandchildren and later generations.

Wouldn’t that be a nice legacy to leave grandchildren?

June 7 2021

Death Tax Ambush: 48% Capital Gains Tax Surprise

As many were departing for a long Memorial weekend, the Biden Administration released the long-awaited Green Book. Many of us in the life insurance side of the financial services industry have been talking and writing about Biden’s campaign promise to tax the wealthy by rolling back Trump’s tax cuts -specifically by reducing the estate and gift exemption and increasing the tax rates. At the same time, some acknowledged that Biden also promised to raise capital gains tax by eliminating the benefit of step-up basis at death, but many commentators acknowledged the difficulty of implementing such a change. Many believed rolling back the estate and gift tax exemptions and rates were more likely than the elimination of step-up in basis. Much to our surprise, the Green Book does not propose any estate and gift tax increase but proposes significant changes to capital gains taxation. Following is a summary of the capital gains proposal: Read Full PDF

May 25 2021

Diversify Your Concentrated Position

Diversify Your Concentrated Position: Help lower volatility, increase portfolio predictability and potential reduce taxes

Written by Terri Getman J.D.*, CLU, ChFC, RICP, AEP (Distinguished)

A hallmark of wise planning is to diversify risk across a range of assets and asset types because any one asset or asset class might underperform in a given year. Diversification can help offset underperformance. This risk can be magnified when an individual has a heavy concentration in one stock or asset. While capital gain rates are currently at near-historic lows and the stock market at an all-time high now may be a time to consider repositioning because President Biden campaigned on increasing capital gains tax – both during life and at death. Where an individual has a life insurance need, a life insurance death benefit might also help add stability to an overall financial plan.

DID YOU KNOW?

Too much of any one company’s stock increases your exposure to company specific risk and stock price volatility.
President Biden campaigned on replacing the 20% capital gain tax rate with ordinary income tax rate of 39.6% for incomes of over 1 million and eliminating stepped-up basis at death.

MEET JOHN, CEO OF XYZ Inc. – Age 55, nonsmoker, in good health

John currently owns $2 million of XYZ stock (48,780 shares at $41 per share with a cost basis of $15.98 per share). He’s concerned that his current concentrated stock position exposes him to higher levels of market and price volatility. Based on his objectives, net worth, time horizon and risk tolerance, this large position is more than he is comfortable with. John receives $980,000 in wages.

Despite his continued interest in the market returns, John wants a way to:

Minimize his risk exposure to market volatility.
Leverage his legacy to his children.
Reduce risk associated with economic and tax uncertainty.

IF YOU HAVE A CONCENTRATED POSITION LIKE JOHN-

Here’s what John’s advisor recommends: Liquidate $1 million $3 million – Stock Portfolio

John sells 24,390 shares of XYZ stock at $41 per share for $1 million. Today he pays a 20% federal capital gains tax, a 3.8% Medicare tax on investment income for federal tax of approximately $145,2391.
If John waits to sell his large concentrated stock position and President Biden’s proposal on capital gains is enacted into law John could pay a 39.6% tax rate on the gain of approximately $241,658. After paying taxes based on the $15.98 per share cost basis, John uses some of the remaining $854,761 to buy a life insurance policy.
By selling just a portion of his stock, John reduces his concentrated risk and protects his legacy with a legacy with a death benefit that can pass to his children/family income tax-free.

Read Full PDF