Selling large life insurance policies is seldom easy. No matter how urgent and appropriate the need, advisors must address many obstacles before clients approve the sale. Finding solutions to the hurdles that arise may mean the difference between a big payday and no sale. In larger cases, creative planning is the rule, not the exception.

How to pay the premium

Frequently, clients don’t have enough Crummey beneficiaries to meet the size of the premium. For example, Tom and Jane are age 70 and 67, respectively, and in reasonably good health.

They would like to purchase a $10 million guaranteed survivorship universal life policy with a premium of approximately $175,000 per year. If Tom and Jane only have two married children and are willing to make Crummey gifts to the in-laws, they can gift $96,000 per year ($12,000 per year per donee beginning in 2006).

One solution would be to recommend using some of their lifetime exemption of $1 million each to make up the difference. Use of Crummey powers also means that someone will have to send Crummey notices annually. A gift tax return will also have to be filed with regard to the exemption gift. This amount of compliance usually creates an unwanted expense–and aggravation–and is frequently a deal killer.

A solution to the problem

Tom and Jane have a house worth $1.75 million. Since they’re interested in getting their estate planning in order, we will suggest they put their home into a qualified personal residence trust (QPRT). The trust lets Tom and Jane transfer their home to their children at a “discounted” value.

The Internal Revenue Service has formulas and a methodology for determining the value of the gift. By using some of their $1 million exemption now, they will remove the value of the home from their estates as long as they outlive the term of the trust.

Furthermore, any additional appreciation of the home will occur outside of Tom’s and Jane’s estates. Because one of the motivations for this planning is to facilitate a large life insurance sale, in Tom and Jane’s case we will recommend a three-year QPRT. This will use almost $700,000 of exemption for both Tom and Jane.

When the QPRT term ends, we will not distribute the home to the two children, as is often done. Instead, the house will stay in trust. The trust will still be out of the estates of Tom and Jane, but we will make the trust “defective” for income tax purposes. That means any income that is earned by the trust will be income taxable to them.

Now that Tom and Jane no longer own their home (a trust for the benefit of their children does), they are obligated to pay rent if they want to continue to live there. Fair market rent often can be arbitrary because it is frequently difficult to find “comps.”

However, we often use 10% of fair market value as a guideline. In this case Tom and Jane would pay $175,000 per year in rent to the trust. The rent is not considered a gift to the children, nor is it taxable as income to the children.

Remember, the trust is defective for income tax purposes, which means that in the eyes of the IRS, Tom and Jane are paying rent to themselves. No income tax related to this transaction is due from anyone.

The QPRT would be the owner and beneficiary of our proposed $10 million guaranteed survivorship policy. The rent payments will serve to make the premium payments on the life policy after the third year. During the first three years, Tom and Jane can make a loan to the QPRT to pay the premium.

No Crummey letters are necessary annually. Only one set of gift tax returns will need to be filed (one for Tom and one for Jane) in the year the QPRT is established and the property is transferred. This is a greatly simplified transaction and one that is easy for clients to understand.

A great combo

QPRTs are a basic estate planning tool that have a long history and complete guidance from the IRS. Life insurance is also a critical tool, especially in large estates. By combining and integrating these two tools, one can create a powerful but simple solution that overcomes obstacles faced in implementing a large life case.

While the sale may not happen quickly, it will require less annual “maintenance” and, therefore, will more likely stay in force. Clients generally disdain strategies that are complicated and cumbersome to operate. The more you can simplify transactions for your clients, the more likely you are to complete them.