Prem Financing Alternative Using Grats As An Exit Strategy
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PREMIUM FINANCING
SunSolutions For Life
SM
The Premium Financing Alternative Using GRATs as an Exit Strategy Financial Situation Clients with large life insurance needs are often unwilling or unable to fund premium payments from their current cash flow. Their net worth may be illiquid, for example heavily concentrated in real estate and business interests. They may also be reluctant to convert high performing investment portfolios to cash. Such clients will usually create an Irrevocable Life Insurance Trust (ILIT) to own the insurance, which could result in significant gift tax when gifting the needed dollars to the ILIT.
Possible Solution
Financial Strategy
Finance Company Loan Interest Gifted*
Loan
Grantor
Irrevocable Life Insurance Trust (ILIT)
The Grantor establishes the ILIT, secures the trust loan with additonal collateral, and gifts the amount of the loan interest annually to the ILIT.1
The ILIT applies for a life insurance policy on the life of the Grantor. The Trustee borrows a series of premiums from a third party lender to fund the life insurance policy.3 The trust utilizes the insurance policy’s cash value as part of the required collateral. The trustee then pays the annual premium to the insurance company and pays the loan interest to the lender each year as due.
The additional loan collateral may include the Grantor's assets in the form of marketable securities or a letter of credit from the Grantor's own banking source.2
The applicable loan rate is typically linked to an outside index such as London Interbank Offered Rates (LIBOR) plus an add-on of additonal basis points. The interest rate is in effect for one year at a time and the entire loan will renew each year at the then effective interest rate.
*Subject to applicable gifting codes and regulations. Any gift to an ILIT that is intended to be a present interest and completed gift must be made to an ILIT, which contains Crummey power language. Annual exclusion gifts made to an ILIT can be gift-tax free if they do not exceed $12,000 per individual beneficiary in 2008. In addition, lifetime gifts can be made using the liftime gift tax unified credit exemption of up to $1,000,000. Gifts in excess of these exclusions and exemptions will be taxable gifts. 2 The amount of collateral required will usually include the life insurance cash value and will depend on the type of asset used. For example, stocks may be valued at 70% of the market value while bonds may be valued at 90% of face amount. 3 Banks will only allow Premium Financing with fixed interest rate products such as Universal Life. Variable Life policies cannot be financed. 1
XMSD 44/527 SLPC 19203 08/08 Exp. Date 08/09 PAGE 1 OF 2
FINANCING
Premium Financing may be able to provide an alternative method for funding annual premiums. One must keep in mind however, that the longer the loan is outstanding the greater the chance of incurring gift tax to cover loan interest. Clients in their 70's and older may not have this problem, since they typically plan to use the death benefit to pay off the loan, but for those clients who are younger, this problem will persist unless addressed from the outset of the agreement. Through the use of a Grantor Retained Annuity Trust (GRAT) clients can fund an ILIT with enough assets to pay off a Premium Financing loan, and ultimately avoid gift taxes.
Advanced Markets Group | P R E M I U M
Advanced Markets Group
GRAT Exit Strategy Remainder Value
Asset(s)
Grantor The Grantor transfers appreciating assets to the GRAT. The transfer may be subject to gift tax depending on how the GRAT is structured,4 and may qualify for a discount on the asset valuation based upon the nature of the asset.
GRAT
Annuity Payments
ILIT
The GRAT makes payments in the form of an annuity to the Grantor for a fixed term of years or lifetime.
Loan Repayment
Finance Company At the conclusion of the GRAT term, the remainder value is transferred to the ILIT. The trustee can use the assets from the GRAT to repay the loan.
Results In the early years of the arrangement, the Grantor's outlay is limited to the interest due on the loan, which is considerably less than the insurance premium itself. This will minimize the problems of gifting the full premium amount to the trust and/or liquidating assets to pay for the premium. The use of a GRAT provides the opportunity to pay off the loan before interest payments on the loan may exceed the Grantor’s annual and or lifetime gifting limits, and avoids interest rate exposure for a prolonged period of time.
What You Need to Know About GRATs Advantages
Disadvantages
The property may be gifted at a reduced value The value of the property is frozen for gift tax purposes Retain right to receive income, while gifted property is out of client's estate
If the client dies during the GRAT term, the property will be included in the grantor’s estate at current fair market value The GRAT property may under-perform during the GRAT term
A “zeroed out” GRAT occurs when the value of the Grantor-retained annuity is essentially equal to the value of the asset transferred to the trust, resulting in a nominal gift or no gift because the remainder interest has virtually no value for gift tax purposes.
4
This information is for general education of producers and contains references to concepts that have significant legal, accounting and tax implications. It is not intended as legal, accounting or tax advice. Clients should consult with their own tax advisor regarding the application of these concepts to any particular situation. Not FDIC/NCUA insured. May lose value. No bank/credit union guarantee. Not a deposit. Not insured by any federal government entity. Universal life insurance is issued by Sun Life Assurance Company of Canada (Wellesley Hills, MA) or in New York, Sun Life Insurance and Annuity Company of New York (New York, NY). All guarantees are based on the claims-paying ability of the issuing company, Sun Life Assurance Company of Canada (Wellesley Hills, MA), or in New York, Sun Life Insurance and Annuity Company of New York (New York, NY). All are members of the Sun Life Financial group of companies. ©2008 Sun Life Assurance Company of Canada. All rights reserved. Sun Life Financial and the globe symbol are registered trademarks of Sun Life Assurance Company of Canada. XMSD 44/527 SLPC 19203 08/08 Exp. Date 08/09 Page 2 of 2
SunSolutions For Life
SM
The Premium Financing Alternative Using GRATs as an Exit Strategy Financial Situation Clients with large life insurance needs are often unwilling or unable to fund premium payments from their current cash flow. Their net worth may be illiquid, for example heavily concentrated in real estate and business interests. They may also be reluctant to convert high performing investment portfolios to cash. Such clients will usually create an Irrevocable Life Insurance Trust (ILIT) to own the insurance, which could result in significant gift tax when gifting the needed dollars to the ILIT.
Possible Solution
Financial Strategy
Finance Company Loan Interest Gifted*
Loan
Grantor
Irrevocable Life Insurance Trust (ILIT)
The Grantor establishes the ILIT, secures the trust loan with additonal collateral, and gifts the amount of the loan interest annually to the ILIT.1
The ILIT applies for a life insurance policy on the life of the Grantor. The Trustee borrows a series of premiums from a third party lender to fund the life insurance policy.3 The trust utilizes the insurance policy’s cash value as part of the required collateral. The trustee then pays the annual premium to the insurance company and pays the loan interest to the lender each year as due.
The additional loan collateral may include the Grantor's assets in the form of marketable securities or a letter of credit from the Grantor's own banking source.2
The applicable loan rate is typically linked to an outside index such as London Interbank Offered Rates (LIBOR) plus an add-on of additonal basis points. The interest rate is in effect for one year at a time and the entire loan will renew each year at the then effective interest rate.
*Subject to applicable gifting codes and regulations. Any gift to an ILIT that is intended to be a present interest and completed gift must be made to an ILIT, which contains Crummey power language. Annual exclusion gifts made to an ILIT can be gift-tax free if they do not exceed $12,000 per individual beneficiary in 2008. In addition, lifetime gifts can be made using the liftime gift tax unified credit exemption of up to $1,000,000. Gifts in excess of these exclusions and exemptions will be taxable gifts. 2 The amount of collateral required will usually include the life insurance cash value and will depend on the type of asset used. For example, stocks may be valued at 70% of the market value while bonds may be valued at 90% of face amount. 3 Banks will only allow Premium Financing with fixed interest rate products such as Universal Life. Variable Life policies cannot be financed. 1
XMSD 44/527 SLPC 19203 08/08 Exp. Date 08/09 PAGE 1 OF 2
FINANCING
Premium Financing may be able to provide an alternative method for funding annual premiums. One must keep in mind however, that the longer the loan is outstanding the greater the chance of incurring gift tax to cover loan interest. Clients in their 70's and older may not have this problem, since they typically plan to use the death benefit to pay off the loan, but for those clients who are younger, this problem will persist unless addressed from the outset of the agreement. Through the use of a Grantor Retained Annuity Trust (GRAT) clients can fund an ILIT with enough assets to pay off a Premium Financing loan, and ultimately avoid gift taxes.
Advanced Markets Group | P R E M I U M
Advanced Markets Group
GRAT Exit Strategy Remainder Value
Asset(s)
Grantor The Grantor transfers appreciating assets to the GRAT. The transfer may be subject to gift tax depending on how the GRAT is structured,4 and may qualify for a discount on the asset valuation based upon the nature of the asset.
GRAT
Annuity Payments
ILIT
The GRAT makes payments in the form of an annuity to the Grantor for a fixed term of years or lifetime.
Loan Repayment
Finance Company At the conclusion of the GRAT term, the remainder value is transferred to the ILIT. The trustee can use the assets from the GRAT to repay the loan.
Results In the early years of the arrangement, the Grantor's outlay is limited to the interest due on the loan, which is considerably less than the insurance premium itself. This will minimize the problems of gifting the full premium amount to the trust and/or liquidating assets to pay for the premium. The use of a GRAT provides the opportunity to pay off the loan before interest payments on the loan may exceed the Grantor’s annual and or lifetime gifting limits, and avoids interest rate exposure for a prolonged period of time.
What You Need to Know About GRATs Advantages
Disadvantages
The property may be gifted at a reduced value The value of the property is frozen for gift tax purposes Retain right to receive income, while gifted property is out of client's estate
If the client dies during the GRAT term, the property will be included in the grantor’s estate at current fair market value The GRAT property may under-perform during the GRAT term
A “zeroed out” GRAT occurs when the value of the Grantor-retained annuity is essentially equal to the value of the asset transferred to the trust, resulting in a nominal gift or no gift because the remainder interest has virtually no value for gift tax purposes.
4
This information is for general education of producers and contains references to concepts that have significant legal, accounting and tax implications. It is not intended as legal, accounting or tax advice. Clients should consult with their own tax advisor regarding the application of these concepts to any particular situation. Not FDIC/NCUA insured. May lose value. No bank/credit union guarantee. Not a deposit. Not insured by any federal government entity. Universal life insurance is issued by Sun Life Assurance Company of Canada (Wellesley Hills, MA) or in New York, Sun Life Insurance and Annuity Company of New York (New York, NY). All guarantees are based on the claims-paying ability of the issuing company, Sun Life Assurance Company of Canada (Wellesley Hills, MA), or in New York, Sun Life Insurance and Annuity Company of New York (New York, NY). All are members of the Sun Life Financial group of companies. ©2008 Sun Life Assurance Company of Canada. All rights reserved. Sun Life Financial and the globe symbol are registered trademarks of Sun Life Assurance Company of Canada. XMSD 44/527 SLPC 19203 08/08 Exp. Date 08/09 Page 2 of 2
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