Overview
This white paper addresses a common concern for ultra-high-net-worth individuals (UHNWIs) when engaging in estate planning: how to move assets efficiently out of the estate while maintaining financial security. The subject of this discussion is a hypothetical client, whose primary planning goal is to ensure the growth and appreciation of his asset scan occur outside his estate for tax purposes. However, he is concerned about gifting large portions of his wealth due to fears of potentially running out off funds.
We discuss using loans to purchase life insurance within a grantor trust as an efficient and flexible strategy. It allows for asset appreciation outside of the estate while ensuring liquidity and financial security for the individual throughout his lifetime. This method mirrors the strategy previously employed by the client in utilizing a Grantor Retained Annuity Trust (GRAT) to transfer appreciation on business stock, helping him understand the mechanics of using a similar loan-based strategy.
Background: The client’s planning goals
1. Client wanted to move assets out of his estate to reduce exposure to estate taxes.
2. He wanted to ensure the growth and appreciation of his assets occur outside of his estate, preserving their value for future generations.
3. He is concerned about giving away too much of his wealth, fearing that he might not have enough for his needs during his lifetime.
4. He is interested in having access to his capital without reducing its tax-efficient growth potential.
Gifting Concern & Proposed Alternative
While gifting is a common strategy in estate planning, it raises significant concerns for individuals who worry about running out of money during their lifetime. For our client, the idea of giving away substantial assets to a trust or family members is not desirable. To address this, we propose an alternative strategy: using loans to purchase a life insurance policy within a grantor trust.
Structure Of The Plan: Loan To A Grantor Trust For Life Insurance Purchase
(Refer to chart for example)
1. Establishment of the Trust. A grantor trust is created by the client. The trust will purchase a life insurance policy on the client’s life. See graphic below with numbers pointing to different aspects of the design
2. Loan to the Trust: Instead of making an outright gift, the client loans funds to the trust of $125,000 per year. The loan is structured at appropriate interest rates, ensuring the transaction is viable and avoids adverse tax implications.
3. Life Insurance Premium Payments: The trustee of the trust uses the loan proceeds to pay the premiums for a life insurance policy, also of $125,000 per year. This policy is structured so that its death benefit can grow substantially over time, like how the client used a GRAT in the past to remove appreciating business stock from his estate.
4. Repayment of the Loan: The loan to the trust is structured with an interest-bearing promissory note. This creates a receivable due back to the client, giving him financial security in the form of potential access to the loan principal and interest. The loan can be repaid during his lifetime or upon his death. The receivable (loan principal and interest) is included in the client’s estate, providing a source of liquidity and a balance sheet asset that offsets the need for gifting significant assets out of the estate.
5. **Tax Treatment: ** Upon the client’s death, the death benefit of the life insurance policy is outside of the client’s estate, and the appreciation of the death benefit is excluded from estate taxes. However, the loan receivable is included in the estate for tax purposes, ensuring there are no unintended transfer tax consequences. This structure provides peace of mind for the client, as he retains control and access to the funds loaned to the trust.
Growth Of The Life Insurance Death Benefit
A key advantage of this approach is the structuring of the life insurance policy in a way that allows for meaningful death benefit appreciation. By structuring the life insurance policy to allow for significant growth in the death benefit, the client ensures that the appreciated value of the policy remains outside his estate, providing significant wealth transfer opportunities to future generations. The asset left in the estate is the loan receivable, which is capped by the amount of the loan principal and accumulated interest.
Parallels With Grat Strategy
The client’s familiarity with using a Grantor Retained Annuity Trust (GRAT) to transfer appreciating assets out of his estate provides a foundation for understanding this life insurance loan strategy. The GRAT allowed him to move the future appreciation of his business stock out of his estate while retaining annuity payments, offering financial security during this lifetime.
Similarly, by using loans to purchase life insurance, the client is applying the same logic: he’s removing the future appreciation (the growth of the life insurance death benefit) from his estate, but without giving up the underlying capital. The receivable created by the loan gives him the peace of mind that he can access the principal and interest if needed. Using this strategy, the client moved over$3.6M of appreciation from his estate.
Benefits Of The Strategy
1. Efficient Transfer of Appreciating Assets: The life insurance death benefit grows outside of the estate, reducing the estate tax burden for the client’s heirs.
2. Flexibility and Liquidity: The client retains control over the loaned funds, giving him flexibility to call for repayment during his lifetime if needed. The note payable to his estate ensures that he is not overly reliant on a strategy that might deplete his financial resources.
3. Minimal Gift Tax Exposure: Since the trust is funded through loans and not gifts, the client avoids using up lifetime gift exemptions or paying gift taxes.
4. Familiar Structure: This strategy mirrors the GRAT concept by shifting the appreciation out of the estate while allowing the client to retain access to the principal. The strategy enjoys an improved taxable equivalent rate of return due to the step up in basis given to life insurance policies held in irrevocable trust.
Conclusion
For UHNWIs like our hypothetical client, using loans to purchase life insurance within a grantor trust offers a compelling strategy for achieving estate planning goals. This approach efficiently removes the appreciation of the life insurance death benefit from the estate while ensuring financial security through the retention of a loan receivable.
For those with concerns about gifting too much wealth and running out of money, this loan-based strategy offers a flexible and effective solution, closely paralleling other proven techniques like the GRAT. Through this method, the client can confidently plan for the future, knowing that his assets are being transferred efficiently, without sacrificing financial control during his lifetime.
Carolyn Rogers serves as Vice President of the Life Group at Howard Insurance. In her role, she works directly with the firm’s clients and advisors on the planning, placement, and servicing of sophisticated life, disability, and long-term care insurance solutions. She can be reached atcrogers@howard-insurance.com
This paper is strictly for educational purposes and does not amount to legal or tax advice.
