Today’s life insurance planning environment provides sophisticated techniques to help clients create, retain and transfer their wealth. Many of these concepts initially offer great tax advantages, such as reduced gift taxes, but these advantages decrease over time.
Examples: premium financing and split-dollar plans, which provide substantial tax benefits and leverage of available funds at plan inception but become more costly to the client with each passing year. An exit strategy for such plans is therefore a must.
However, using policy cash values for this purpose in the current low interest rate environment is difficult; other rollout approaches may lead to substantial gift taxes.
What other options are available to clients? For the charitably inclined, the same low interest rate environment that suppresses policy cash values can make a charitable lead trust a great, if often overlooked, exit strategy.
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A donor makes a contribution to the charitable lead trust (CLT) and the designated charity receives a payout from that trust for a period of time. The payout could either be specified, as in an annuity trust, or vary with the value of the trust assets, as with a “unitrust.”
The duration of the CLT can be for a term of years or for the donor’s lifetime. At the end of the payout period, the remainder value of the trust passes to the remainder beneficiary, which could, if desired, be an irrevocable life insurance trust (ILIT).
When the CLT is created, the donor receives a potential income tax deduction based on a complicated IRS calculation and the current ?7520 rate (an explanation of this calculation is beyond the scope of this article). The donor also is deemed to have made a taxable gift to the remainder beneficiaries. The gift amount will generally equal the fair market value of the asset contributed to the trust less the potential income tax deduction.
When a CLT is funded with a highly appreciating asset, the taxable gift can end up being significantly less than the ultimate value passed to the remainder beneficiaries. As a result, the CLT can be a very gift tax-efficient way to transfer wealth. In some cases, the plan can be structured so that the taxable value of the gift is zero, though the actual remainder value of the trust is projected to be much higher.
To illustrate, consider Ellen Ripley, who is 50 years old and recently widowed. She and her husband had built a successful salvage business that is now worth about $20 million. She needs at least $10 million of life insurance, but cash flow is tight due to her husband’s death.
Ellen has heard of premium financing but is concerned about interest rate fluctuations. She realizes she needs a way to get out of any financing arrangement should interest rates rise dramatically. Ellen also wants to minimize gift taxes. Her college-aged daughter, Rebecca, has an interest in eventually joining the business, so Ellen would like to preserve her gift tax exemption to make planning for this transfer easier when the time is right.