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Estate Planning: The Cost of Waiting

Following the 2017 Tax Act, many advisors have asked how to respond to clients who say that there is no urgency in planning given the tax changes. To address this lack of urgency, consider the following:

  • the non-tax needs of the family–including liquidity to equalize gifts among heirs,
  • the preference heirs may have to buy each other out of unwanted assets, and
  • the desire to ensure long-term care for a special needs family member.

2026 Sunset

It is also important to consider the cost of delayed planning, taking into account the 2026 ‘sunset’ of the lower tax exemption, as well as the size of their current estate, its expected growth in 7 years and beyond, and the client’s age and health. Therefore, the actual cost of delayed planning can be significant by 2026.

Isolating Life Insurance Costs

The chart below illustrates the costs for a married couple, both age 60, preferred non-smokers, purchasing a hypothetical $10M survivorship universal life insurance policy today– and compares this to the projected costs of the policy ten years from now:

Hypothetical Premiums on $10M of Survivorship Universal Life
Male Age 60/Female Age 60, Preferred Non-Tobacco (Preferred NT)

Insured(s) Rating(s) $10M * Full Pay Prem. Increase %
M60/F60 Preferred NT $91,583 Due to 10-Year Delay in Planning
M70/F70 Preferred NT $154,325 169%
Standard NT $208,791 228%
Table B (150%) $268,390 293%
M70/F70 Standard NT $304,595 333%
M70/F70 Standard NT $394,533 431%

Now assume a $3M cash gift (within the tax-free exemption amount) is made to an Irrevocable Life Insurance Trust (ILIT) today, assuming 5% annual income is generated from that gift to pay the annual premium. Note that the trust is assumed to be drafted as a “grantor” trust so that the annual income taxes of the trust are paid by the grantor (mom/dad), leaving more in the trust to fund premiums. This payment of tax by mom/dad can be viewed as an additional tax-free gift to the trust. Assuming the trust is properly structured, there should be no estate tax inclusion of the life insurance proceeds or the other trust assets.

Now let’s assume assume that mom/dad need more insurance than what $3M gift will buy but do not want to make completed gifts today. They simply want to wait.

In this case, they can enter into a family split dollar arrangement with the trust to fund the full premium on the hypothetical survivorship life insurance policy. The $3M gift, in this case, can be used by the trust to roll-out or exit the split dollar plan in the future and not to pay the annual premiums.  That is, a family split dollar arrangement is a loan between family members and must be repaid according to specific split dollar rules. There’s no completed gift. Under these rules, the loan balance must be calculated as the greater of cumulative premiums paid, or the policy’s cash surrender value, whichever is greater. In this case, the roll-out is assumed to be year 23, before policy cash values exceed cumulative premiums.  Results? Mom/Dad get their money back in the form of the roll-out, the $3M.

Again, a family split dollar plan, also referred to as private split dollar, is a loan arrangement between the trust and mom/dad. However, instead of the trust paying mom/dad a fair market rate of loan interest annually as in a typical run of the mill loan, the cost of this arrangement is measured using the economic benefit cost of the life insurance, generally defined as the annual term cost of the insurance amount, based on age, as disclosed by the life insurance company. This annual insurance cost is either paid annually by the trust or construed as a gift by mom/dad to the trust.

The annual term cost is very low when mom/dad are young since a joint life table of rates is used to measure the term cost on a survivorship policy.   So in the early years of the split dollar loan, the cost to the trust is very low.  The rates become prohibitively expensive, however, as the couple gets older. In fact, when one of the two dies, the rates jump up considerably on the life of the survivor since, at that point in time, the term cost table for a single-life replaces the lower cost joint-life table.

Notably, another benefit of a private split dollar plan is that although the premiums are higher in a rated case, the annual economic benefit reflects attained age and insurance amount only and does not reflect the rating; resulting in a lower gift tax cost than otherwise would have been paid if the full premium was gifted to the trust.

The loan in a family split dollar arrangement must be repaid before the term costs become prohibitive; thus, the need for a roll-out using the $3M gift initially made to the trust.

So, What Does All of This Mean?

The chart below illustrates a hypothetical amount of life insurance coverage — $17 million of survivorship universal life insurance– that is financially supported in a private split dollar arrangement in which a $3M gift is made to a grantor trust, as described above. Significantly less coverage is supported ten years from now under the exact same transaction when planning is delayed, due to changes in age and health status. Take a look at this hypothetical:

Insured(s) Rating(s) Life Insurance Amount Supported Death Benefit Reduction Due To Waiting
M60/F60 Preferred NT $17.0M Due to 10-Year Delay in Planning
M70/F70 Preferred NT $10.5M ($6.5M)
Standard NT $8.0M ($9.0M)
Table B (150%) $6.3M ($10.7M)
M70/F70 Standard NT $5.5M ($11.5M)
M70/F70 Standard NT $4.2M ($12.8M)

Planning Without Giving Assets Away?

As illustrated, if clients do not want to give away an asset or cash outright, they can enter into a loan arrangement through the use of a private split dollar arrangement.

Alternatively, a fair market intra-family loan at a fair market rate of interest can be established and may provide much more flexibility than private split dollar. This is often referred to as private financing.

Private Financing- Delay Gift, Not Planning

By loaning an income asset or cash using a fair market loan arrangement, in which a fair market rate of loan interest is charged to the trust, mom/dad do not make a completed gift now. They can decide later whether or not to:

  • forgive the note, thereby making a gift later,
  • refinance it, or
  • have the trust repay it,

All of this will be based on what happens with tax law and family dynamics at the time. The family buys time to decide what to do, while locking into insurability. In a way, the family is delaying the completion of a gift but not the planning.

The loan can be in the form of a lump sum loan of cash designed to fund annual premium and repay the loan principal. It can also be designed as a combination of a lump sum loan and a cash gift. Alternatively, a cash loan can be made to the trust annually in the amount of the premium, for a set term of years.  Again, there’s time to decide on whether or not to complete the gift.

Unlike private split dollar in which the economic benefit rate (cost of pure insurance death benefit) is used as a measure of the loan cost the trust must pay, the government published AFR rate, or Applicable Federal Rate, is the rate that is used in private financing, and is based on the month the note is established. The rate can be locked for the term of the note. Since AFR rates continue to be low, this allows more of the money in the trust to be used for insurance instead of paying loan interest. However, the window is closing as interest rates increase.  That is, the difference between what the  trust earns and what is paid as loan interest funds the premium.  We refer to this as arbitrage. The arbitrage pays the premium.  Take a look:

Take a look at the relationship between the AFR rate, the assumed rate of return in the trust, and the resulting net arbitrage available to fund the premium. As interest rates increase, less is available to fund premium.  What is assumed as the trust’s return also plays a key role. Again, because the trust is assumed to be structured as a “grantor” trust, the trust’s income taxes are paid by mom/dad and therefore more of the trust earnings remain in the trust to pay the premium.

1 Assumes Grantor Trust so that taxes on annual trust earnings are paid by grantor

The cost of waiting to plan can be high.  There is still time, while interest rates remain low, to do planning without giving assets away. Through the use of private premium loan arrangements, clients can lock in insurability without making a gift, while preserving flexibility to decide later about completing a gift.

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Lina Storm, CLU®, ChFC®, MBA

Lina Storm, CLU®, ChFC®, MBA

Vice President, Field Marketing at Highland Capital Brokerage
Lina Storm serves as Vice President, Field Marketing for Highland Capital Brokerage. She has an extensive background in marketing insurance and advanced planning strategies having spent most of her career leading the marketing for John Hancock’s notable Advanced Markets Group. She has been an industry thought leader, industry columnist, advisor’s coach, trainer, speaker, and brand strategist—helping advisors position their expertise, add value, and drive sales. Lina is a CLU®, ChFC® and received her B.A. from Trinity College in CT and an M.B.A. from Rensselaer Polytechnic Institute in New York.
Lina Storm, CLU®, ChFC®, MBA

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