Background: Changes in the Federal Estate Tax laws combined with changes in Life Insurance products has made reviewing existing Trust Owned Life Insurance (TOLI) policies something that everyone should be doing.
Our Case: One of our clients has been “short pay” funding a life insurance policy over the past fifteen years. The policy was designed to provide $1,000,000 of benefits to the heirs of the estate upon the death of the surviving spouse. At the time the Trust was constructed, settling the husband and wife’s estate would have triggered significant estate taxes upon the surviving spouse’s death. In 2009, the future of Estate Tax Laws was in a significant state of flux, but for that year the law allowed $7,000,000 to be passed to heirs with no tax (if proper legal documentation is provided) and thus had reduced the need for cash to pay Estate Taxes to zero. The client, who was allocating $15,000 a year to the policy funding was also having cash flow issues and had alternative uses for this same $15,000.
The Question: The questions then became: What does the Trustee do with the cash values of the current policy? How much cash flow can the client save?
The Results: Through our TOLI review process we determined two potentially desirable results:
- First, we could move the existing cash values to a new policy where the product design would call for no future premium deposits for as long as the husband and wife would live and guarantee to pay out a death benefit at the second death. The death benefit would be reduced from $1,000,000 to $650,000 but the $15,000 in annual premiums would not be required going forward. The heirs would receive this $650,000 at some future date, free of both estate and income taxation. This portion of the client’s estate would also be shielded from creditors including the risk of long term care providers.
- Second, we could surrender (cash in) the policy and distribute the cash value to the trust beneficiaries (note the Trust must allow for this option). The cash could then be used to start a partnership composed of the family members with the intent of acquiring some desired real estate investments. The dad and mom owned some desired real estate and they would contribute this real estate as their capital to the new partnership. The children would contribute the cash. The desired real estate had some existing debt (which dad and mom had been cash flowing) and the cash from the children could totally pay off the debt. Dad and mom would then do annual partnership interest gifting which would require no out of pocket cash flow.
Bottom Line: In this case the client and his family decided on Option #2. When processing the request to surrender the policy we observed that it was a Whole Life Contract with the anniversary date only fifteen days away. The client was advised to wait fifteen days as this qualified him for a $5,000 dividend that would have been totally forfeited had he quit even one day before the anniversary. The dad and mom are happy as they have reduced their annual outgoing cash flow by the premium of $15,000 and the debt service on the desired real estate which amounted to another $15,000 or a total less outflow each year of $30,000. Also, they were extremely happy to get the bonus $5,000 by waiting only fifteen days. Reviewing TOLI is important and this case certainly shows a benefit in so doing.
This is a hypothetical example for illustrative purposes only. The experience of this client may not be representative of the experience of all clients and is not indicative of future results. Any tax advice contained herein is of a general nature and is not intended for public dissemination. Further, you should seek specific tax advice from your tax professional before pursuing any idea contemplated herein. This advice is being provided solely as an incidental service to our business as financial planner. Securities offered through ValMark Securities, Inc. Member FINRA, SIPC. Financial Planning and Investment Advisory Services offered through B & E Investment Advisers, Inc. Business & Estate Advisers, Inc. and B & E Investment Advisers, Inc. are separate entities from ValMark Securities.