Case Studies

What’s New?

Case Studies in Estate Planning
Good question. After attending one major national estate planning conference and another conference sponsored by one of the best domestic life insurance carriers in the U.S. it seems not too much, at least based on the information provided. But not all is as it seems. If you stay within the conventional then there is not much new. But if you are willing to look beyond the conventional then you will be pleasantly surprised.

The Conventional Planning Issues

Trading one tax for another

One of the most prevalent estate tax reduction techniques used by the legal profession is shifting wealth from one generation to the next. Wealth shifting can take many forms including family partnerships, GRATs and GRUTS, other forms of trusts, long term gifting programs, and the list goes on. If the high net worth client lives long enough, has the discipline to consistently follow the rules, and has the appetite for the administration issues involved these techniques will generally be successful.

However, these techniques have a tax consequence. They essentially change only the nature of the ultimate tax. While the estate tax may be reduced there is another tax that will come home to roost at some point. Capital gains tax at the federal level and, where applicable, the state level will be imposed when the shifted wealth is sold. Based on what we know today the capital gain tax will be less than the estate tax but it is still a tax.

The Utility of the shifted wealth

The shifted wealth comes with some baggage. How do the heirs use it? If the heirs want to spend the shifted wealth they either must sell all or a part of the wealth, or borrow against it. If they sell the wealth, capital gains tax will be imposed on all appreciation. Since the tax basis of the shifted wealth is carried over from the client the taxable appreciation could be significant. If the heirs decide to borrow against the property they will incur the loan set up fees and the ongoing interest, both of which are paid to unrelated third parties.

Early death of the client

While it is unlikely a healthy client will die early it does happen. Where it does, the wealth shifting program ceases and the future estate tax benefits are lost. This could be very problematic especially if the client needed 20 or more years to shift an appreciable amount of his/her property.

Administration, discipline and changes in the law

Long term wealth shifting programs demand discipline and good administration to work. Many plans fall apart because of poor administration, a lack of the long term discipline necessary to continue/complete the plan, or legal changes that road block the plan.

Same old issues

The issues set out above are not exhaustive but they are the same old issues that estate planners keep complaining about. All were discussed at the conferences, all continued to be written about with no new solutions. Why? Good question as there is a solution.

The Solution

The solution is a very simple concept and that concept is life insurance. In order to see life insurance as the nearly perfect solution the estate planning professional community must stop thinking of life insurance as a product that must be purchased in a very controlled environment. Understandably this is a tall order. However, it is legally possible to use life insurance as a concept and not as a product. By removing the controlled environment the concept of life insurance can then be developed into a custom designed and implemented contract of life insurance.

Cost of life insurance

Remove the controlled environment in which U.S. life insurance companies operate and the costs of a custom designed and executed life insurance contract can be negotiated, be understandable and completely transparent, and average less than 100 basis points per year. In most cases this is less than the tax cost of a traditional wealth shifting plan. Think about it; if the shifted wealth generates 3% a year in taxable income a client who is in a combined 40% federal and state income tax bracket pays 120 basis points a year in tax cost. In a combined 33% tax bracket the tax cost is 100 basis points.

Self completing

Since the customized contract of life insurance has a death benefit, the plan is self completing if the client dies unexpectedly. The amount and timing of the death benefit can be built into the contract based on the client’s preferences to cover this issue. The gain realized from the death benefit indemnifies against an early death and is income tax free.

Utility of the wealth shifted through the custom life insurance contract

Life insurance enjoys a tax advantage no other form of property does. Cash can be obtained from the life insurance contract tax free. The owner of the contract can withdraw funds up to the tax basis in the contract and pay no income tax even if there is a gain in the investment component. Loans can also be arranged. If arranged for properly the interest paid on the contract loan will be paid back into the contract’s account value and can useful in helping the client to further reduce his or her taxable estate income and gift tax free. The interest paid on a custom contract loan benefits the heirs and not unrelated third parties as is the case with conventional loans.

At death the shifted wealth in income tax free

When the client passes away the custom contract of life insurance matures. One hundred per cent (100%) of the proceeds paid will be income tax free. The result is there will be complete tax free utility of the proceeds.

Case Study #1

(Comparison to taxble investment)

Client is a wealthy couple who want to shift as much as possible to next generation and pay no gift tax. Husband and wife are 68 and 66 and both are in good health.

Client wants to take advantage of the current gifting amount and give away $10,000,000. Assume the gifted funds can be invested to earn a constant 5% gross yield per year. To accomplish this objective the funds will need to be invested in a taxable bond portfolio. The taxable investment portfolio and the custom contract investment portfolio are identical. No income tax is imposed on the invested funds in the life insurance contract but there are costs associated with the contract. The funds invested outside the life insurance contract will be taxable. Interest on taxable bonds is subject to ordinary income tax. But let’s tip the scales a bit in favor of the taxable investment and assume only 3% of the 5% is currently taxable with the 2% per year being treated as appreciation subject to future capital gains tax. The client’s combined state and federal ordinary income tax bracket is 40%.

The clients have good family histories and believe they will live a long time. They also want to be able to coordinate their life insurance contract to work with additional future estate planning as well as provide access to the account value in case their heirs need some help. Their life insurance contract, therefore, was custom designed to deliver the maximum death benefit late in life, allow tax efficient access to the account value, and coordinate with other estate planning techniques.

The chart below shows how much wealth is shifted over time. The Taxable Investment portfolio shows the net amount available before capital gains tax. The After Tax Amount is the amount left over after a combined 20% tax is deducted from the gain.

Year Custom Life Contract Taxable Investment After Tax Amount
5 $29,725,011 $11,404,289 $11,252,715
10 14,677,172 13,742,160 13,321,612
20 22,767,572 19,953,934 18,745,744
30 32,854,632 28,973,573 26,504,903
Age 100 41,854,764 34,913,133 31,566,867

At no time did the Taxable Investment outperform the Custom Life Contract. The costs of the custom contract were also transparent, negotiated, guaranteed, and averaged less than 77 basis points over the time frame shown. The value shown for the Custom Life Contract is net of all costs. Proper design of the death benefit will help assure the maximum tax free death benefit will be delivered when the client feels it is needed the most. It is especially important to stress the guaranteed nature of the costs. Products of life insurance typically project on a “current” or non-guaranteed cost basis. Such a projection is unrealistic.

So what is new?

The ability to treat life insurance as a dynamic and efficient estate planning concept that can be developed into a highly cost efficient contract of life insurance that improves the overall estate tax planning result. Only CastleRE provides this unique ability. It is removed from the controlled environment that acts as a barrier to unlock the tremendous planning opportunities of the concept of life insurance.

Case Study 2

(Loan Arbitrage)

Same facts used in Case Study #1 are used in Case Study #2. In this case the clients, as part of their overall estate plan, had the Custom Life Contract designed so an additional $1,000,000 per year could be added gift tax free. Starting in year 6 a loan will be taken from the Custom Life Contract in the amount of $10,000,000. The annual loan interest rate designed into the contract was 10%. The loan will be designed so the clients pay the $1,000,000 of interest each year starting at the end of year 7 with the anticipation the principal being paid back at the end of year 30. Principal may be paid back at anytime, however. The 5% bond interest noted in the Case #1facts will not be earned on the loaned amount. However, the remaining Custom Life Contract account value and the interest payments made will earn the 5%.

The Custom Life Contract was also designed to allow the repayment of the contract loan within a reasonable period of time after the death of the insured, in the event the insured client died prior to the time the loan was repaid. The numbers below assume the $10M is paid back and not netted from the death benefit.

The clients have further structured their estate so income and gain on the borrowed $10M will go to the benefit of children and grandchildren.

The result is the clients will be able to move an additional $24,000,000 out of their estate income and gift tax free. The Custom Life benefit now looks like this.

Year Custom Life Contract Taxable Investment* Custom Life Loan
5 $29,725,011 $11,404,289 $29,725,101
10 14,677,172 13,742,160 15,719,288
20 22,767,572 19,953,934 30,847,623
30 32,854,632 28,973,573 50,606,453
Age 100 41,854,764 34,913,133 74,057,32

CastleRE takes no part of the interest paid on the Custom Life Contract. This benefit is not available with conventional life insurance products.
*Not reduced for capital gains tax