Advanced Life Insurance Concepts

Estate Planning

What is Estate Planning?

Estate planning involves preserving your estate for the transfer to your heirs and the proper distribution of your estate’s assets. Proper planning is important to avoid dying intestate which means passing away without a will or trust that provides instructions as to how your estate is to be transferred and to whom.

A will is a legal document created by the owner of an estate that sets forth his or her plan for the disposition of assets after death. In most cases, wills need to be in writing and witnessed by another party. In addition, the testator (the person creating the will) must be competent and free of duress at the time he or she makes the will.The Unlimited Marital Deduction.  Provision that allows your surviving spouse to inherit all of your estate free of estate and gift taxes at your death (your spouse must be a U.S. citizen to qualify for the marital deduction). However, once your surviving spouse dies, his or her estate may be subject to estate taxes depending upon the value of the assets in the estate. Proper planning, including use of trusts, can help alleviate these estate taxes.

What is a Trust?

A trust is an agreement made between two parties for the benefit of a third party. The Trustee holds legal title to property for the benefit of others.
A life insurance trust is a trust formed to own a life insurance policy. An accountant or attorney can help set up a trust. Trusts can be revocable or irrevocable.

What is an Irrevocable Trust?

An irrevocable trust is a trust in which the grantor cannot change the terms of the trust or terminate it. In addition, the grantor does not have access to the funds in the trust. Often such a trust is funded with life insurance and called an Irrevocable Life Insurance Trust (ILIT).

What is an Irrevocable Life Insurance Trust  (ILIT)?

Life insurance is a unique asset in that it assumes its greatest value at the time of greatest need: at the demise of the insured.
The problem with large amounts of life insurance, however, is that the full face amount of the policy can be taxed in the estate of the insured if they own the policy.
To avoid this occurring, it is important to establish an alternative entity as the owner of the insurance.
The most common method is for the insured to create an Irrevocable Life Insurance Trust (ILIT) which will apply for, own and pay the premiums on the insurance.  If properly administered, this approach will have the result of bypassing estate inclusion at the death of the insured.  This is normally considered the most efficient method of producing large amounts of liquidity at the moment it is most needed: when taxes or debts are due.
Typically, the grantor of the trust will make gifts to the trust each year to pay the premium.  In order to keep the insurance out of the estate, it is imperative that the gifts qualify under the Annual Gift Exclusion.  This is accomplished through the use of annual letters to the beneficiaries of the trust by the Trustee, offering them a window during which they can withdraw the gift.  If that window expires or the beneficiaries decline this right in writing, the Trustee can use the gift to pay premiums or for other purposes allowed by the Trust document.  These letters are usually referred to as “Crummey Letters,” after the court case wherein they were first utilized.  They must be done each year a premium gift is made.

The Charitable Deduction

You can donate an unlimited amount of assets to a qualified charity free of estate and gift taxes. This is one way to make sure you are not paying estate taxes (or lowering your estate tax exposure). The amount contributed to charity is fully deductible before the estate tax rate is applied. Some estate holders prefer to have control over who gets the benefit of their estate. They may prefer to select a charity or cause they care for rather than giving the funds to the federal government. There may be other tax deductions available to charitable donations. You may be able to reduce your income tax and capital gains tax on appreciated assets.

IRC Section 2035

This section of IRS code is also known as the three-year rule. It essentially says if an individual dies within three years of transferring certain assets out of his or her estate then those assets are subject to federal estate taxes. It is important to avoid being subject to the three-year rule with regards to your life insurance. Many people use life insurance as an important estate planning tool by placing a policy in an irrevocable life insurance trust. To avoid being subject to IRC Section 2035 create the irrevocable life insurance trust and then have the trust apply for the life insurance policy instead of obtaining the policy first and then creating the trust.

Estate Planning and Life Insurance

You work a lifetime to accumulate an estate; however, at your death the assets you pass onto your heirs may be subject to federal estate taxes and state inheritance taxes. If your estate is subject to estate taxes, taxes are due usually within 9 months of your death. Life insurance can play an important role in estate planning by providing the liquidity necessary to pay estate taxes and other expenses and avoid a “fire sale” of highly illiquid assets. Some expenses that must be paid upon an individual’s death may include:

  • federal estate taxes
  • state inheritance taxes
  • probate fees
  • legal and administrative fees
  • debts
  • funeral expenses

Options to pay estate taxes and expenses include:

  • Use cash (assuming sufficient cash available).
  • Borrow the money (assuming loan can be secured on favorable terms).
  • Pay the IRS in installments under IRC Section 6166 (only available for closely held family businesses or farms and there will be an IRS lien placed on the business).
  • Pre-pay now by purchasing a life insurance policy with the possibility of paying pennies on the dollar. The funded irrevocable life insurance trust (ILIT) can be one of the most cost-effective ways to pay for estate taxes.

Business Planning

Buy/Sell Agreement

A Buy/Sell Agreement is a contractual agreement that provides for the continuation of a business in the event of the death or disability of a sole proprietor, partner or shareholder. An agreement may stipulate that, upon the death of a shareholder or partner of a company, the company or other partners buy back the deceased’s interest in the business. Life insurance is commonly used to fund buy/sell agreements because it provides both liquidity and tax advantages in funding the transaction.
The following are important reasons to use a funded buy/sell agreement:

  • Liquidity – A funded buy/sell agreement creates a market instantly for the deceased’s share of the business. Otherwise, if a funded buy/sell agreement were not in place, the purchase of the deceased’s stake in the business would have to come out of the company’s working capital (if there was enough to fund the purchase). In addition, if an outside party were to purchase the deceased’s share, the timing of the transaction could result in a lower valuation of the company because of the death of a key owner and the fact that the deceased’s family wants to sell in a potentially soft market.
  • Transition of Business – A funded buy/sell agreement assists in the efficient preservation and transition of the control and management of the business.
  • Estate Planning – A funded buy/sell agreement can provide cash for potential estate taxes and settlement costs and establish a valuation of the deceased’s business interest for estate tax purposes.
  • Cost – a funded buy/sell agreement funded with life insurance can be inexpensive (the cost for the purchase of a business is essentially the premiums paid for the life insurance policy).

Life insurance provides a simple way to administer a funding vehicle for the purchase of the deceased’s ownership according to the terms of the buy/sell agreement. The business also protects itself from any future drain on working capital, damage to its credit position and/or the legal or financial problems that could arise out of the company’s inability to fund the buy/sell agreement with its own income.
Buy/sell agreements may be set up in conjunction with Sole Proprietorships, Partnerships and Corporations. The method for each is a little different. Below you will find a general description of the options available for each type of business.
How a Buy/Sell Agreement funded by Life Insurance works

Sole Proprietorship

If a sole proprietor has a key employee that has the desire to purchase the business in the event of the sole proprietors death, a buy/sell agreement can facilitate the key employee’s purchase of the deceased’s business. The sole proprietor and the key employee would enter into a buy/sell agreement, and the key employee would purchase a life insurance policy on the life of the sole proprietor. Pursuant to the buy/sell agreement, upon the death of the sole proprietor, the key employee uses the death benefit to purchase the sole proprietors business from his estate.

Partnership

Cross-Purchase Method
The Cross Purchase Method of entering into a buy/sell agreement works best if there are a small group of partners (preferably two). The partners enter into a buy/sell agreement and each partner buys a life insurance policy on each of the other partners lives. Pursuant to the agreement, upon the death of one of the partners, the surviving partners use the death benefit from the above-mentioned policies to buy the deceased partner’s business interest from his or her estate. The surviving partners then own all of the partnership while the deceased partners estate receives the funds from the sale of the deceased partners share of the partnership.

Entity Method
The Entity Method of entering into a buy/sell agreement offers the advantage of simplicity over the Cross-Purchase Method if there are more than two partners or if there is a likelihood of more partners joining the business later. In this scenario, the partnership and each partner enter into a buy/sell agreement. The partnership buys a life insurance policy on each of the partners lives. Pursuant to the buy/sell agreement, upon the death of one of the partners, the partnership uses the death benefit from the above-mentioned policy to purchase the deceased partners business interest from his or her estate. The surviving partners then own all of the partnership while the deceased partners estate receives the funds from the sale of the deceased partners share of the partnership.

Corporation

Cross-Purchase Method
The Cross-Purchase Method of entering into a buy/sell agreement works best if there are a small group of shareholders (preferably two). The shareholders enter into a buy/sell agreement and each shareholder buys a life insurance policy on each of the other shareholders lives. Pursuant to the buy/sell agreement, upon the death of one of the shareholders, the surviving shareholders use the death benefit from the above-mentioned policies to buy the deceased shareholders business interest from his or her estate. The surviving shareholders will own all of the outstanding corporate stock while the deceased shareholders estate receives the funds from the sale of the deceased shareholders stocks.

Stock Redemption Method
The Stock Redemption Method of entering into a buy/sell agreement offers the advantage of simplicity over the Cross-Purchase Method if the corporation has more than two shareholders or if there is likelihood that additional shareholders will join the business later. In this scenario, the corporation and each shareholder enter into a buy/sell agreement, and the corporation buys a life insurance policy on each of the shareholders lives. Pursuant to the buy/sell agreement, upon the death of one of the shareholders, the corporation uses the death benefit from the above-mentioned policy to purchase the deceased shareholders business interest from his or her estate. The surviving shareholders then own all the outstanding corporate stock while the deceased shareholders estate receives the funds from the sale of the deceased shareholders stock.

Key Person Life Insurance
Maybe your business is operated primarily by one person or maybe your company is run by a small team of executives whose expertise is the lifeline of your business. The premature death of a key person could signal the premature death of the business. With a Key Person Life Insurance Policy, a business can increase the chances of survival if it were to lose a key member of the organization.  Funds from such a policy could:

  • cover business debt
  • leave working capital for a surviving partner(s) to continue the business
  • identify and hire a replacement for the key person
  • provide cash for the business in case there is a major revenue shortfall because of the loss of the key person

Key Person Life Mechanics

The first factor to consider in setting up a Keyperson Life Insurance Policy is to determine how much death benefit is needed. The minimum usually considered is one times the key persons annual income, but other factors need to be considered. What if the business relationships of this person drive half of the company’s revenues? How difficult and costly will finding a replacement be? Are there business debts that would place financial hardship on the company?
Once the death benefit amount has been determined, the business would purchase the policy on the key person. The key person would be the insured and the business would be the owner, payer and beneficiary of the policy. Permanent or term life insurance can be used as a key person policy depending on the needs of the business and how much they are willing to spend.

Executive Benefits

Many variations exist to offer key employees an executive benefit in the form of a life insurance policy owned by the company. Such policies are typically a permanent form of insurance and offer the employer “golden handcuffs” to attract and retain key employees.

Unless otherwise stated herein, pursuant to requirements prescribed by the Internal Revenue Service under Circular 230, Regius Financial, LP must inform you that any U.S. federal tax advice or opinions contained in this communication (including any attachments) are not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction or matter addressed in this communication. Further, Regius Financial, LP does not offer legal or tax advice of any kind. Please consult your legal and tax advisors before entering into any decision.


 


Life Insurance Pages

At Regius Financial.... we provide.... SECURITY FOR LIFE

Top 5 FAQs

1. How much coverage do I need?
2. Is a medical exam required?
3. What payment plans are available?
4. How long does the application process take?
5. Why should I use Regius Financial
Click Here for the answers

Office

14785 Preston Road, Suite 1000
Dallas, TX 75254
(888)-444-8699 TOLL FREE
(972) 663-4444 DIRECT
(972) 663-4455 FAX

Search

To top

 

 

Copyright © Regius Financial, LP 2010 All Rights Reserved. | TERMS / DISCLAIMER | PRIVACY
Regius Financial, LP is an accredited member of the BBB. | Website by Branding Plus Marketing Group