You have worked hard for your money. Don’t you deserve to shelter it from excessive taxation upon your passing?
The answer is “yes.” And for those of you smart enough to reap millions in your lifetime, you should consider an estate tax insurance premium plan that limits additional taxes upon its payout.
Many wealthy individuals need and do buy large amounts of insurance to pay estate taxes upon their death. But those insurance premium payments may be subject to an additional large amount of taxes without proper planning.
One way to avoid this additional tax is a sophisticated planning technique known as Private Financing.
Also known as self-financing, Private Financing is the funding of life insurance premiums through a personal loan by yourself or a family member to an Irrevocable Life Insurance Trust (ILIT). The ILIT also could be funded by your Family. Limited Partnership, Limited Liability Company (LLC) or another existing trust.
How does this work?
- You create an ILIT which ·will pay for a life insurance policy on your life or the lives of you and your spouse.
- You lend money to the trust to pay the premium. This can be done either annually or by a lump sum.
- The ILIT pays back interest on loans based on the Applicable Federal Rate as published monthly by the federal government. This usually occurs at the death of the insured and is paid from the life insurance death benefit.
- At the death of the insured, the ILIT receives the proceeds and repays the premium loan, along with accumulated loan interest. The beneficiaries will receive the ILIT proceeds and, if the beneficiaries of the estate are as well, they will receive the loan net estate taxes.
What are the benefits?
- Your gift tax costs may be eliminated or significantly reduced since the gift is only the loan interest and the full premium.
- Your heirs, in many cases, receive the loan repayment net of estate tax.
- Unlike a commercially financed loan, you do not need approval by a third party and do not have to post collateral to secure the loan. There is no risk of a loan being called by a third party.
Before moving ahead with this Private Financing strategy, consider the following:
- You need enough cash flow or liquid assets to pay the full premium or make the lump sum cash loan.
- Be aware that the loan repayment may be subject to estate tax if you are the lender.
- If the existing trust is the lender, income tax must be paid on the loan interest it receives from the ILIT.
When creating an ILIT, have it drafted by an attorney familiar with such matters in order to take into account income and estate laws (including the generation-skipping tax). Failure to do could result in the adverse tax treatment of trust proceeds.
