Life insurance has long been a tool used to increase one’s ability to transfer wealth from one generation to the next. One strategy used often is to purchase a policy inside of an irrevocable life insurance trust (ILIT). As long as the insured doesn’t retain incidents of ownership, then the death proceeds will not be considered part of the decedent’s taxable estate.
As is common practice, the insured makes regular, ongoing gifts to the trust so the trustee may make the required premium payments. But what if clients want the flexibility to take back the dollars they’ve provided to pay premiums? With the uncertainty surrounding the fate of federal estate tax laws, having more versus less flexibility in this type of strategy might be of interest to some clients.
Or perhaps the client has already used up, or doesn’t want to use, the $1 million lifetime gift tax exemption and/or gift tax annual exclusion (currently $12,000 per year per person). Is there another option to consider?
Private financing is an agreement between two parties in which one party (the lender) lends the other party (the borrower) the funds needed to pay the premiums on a life insurance policy. Private financing arrangements are usually between a family member and a trust he/she created for the benefit of his/her children and/or grandchildren. The borrower is responsible for paying the annual interest on the loan balance and eventually must repay the loans.
There are a number of advantages of this type of an arrangement to the parent, including the ability to:
o Leverage loans into income tax-free death benefits.
o Effectively control the policy without actually owning it.
o Change your mind and get your money back.
o Secure part of the death benefit estate tax-free.
o Avoid limits on the gift tax lifetime exemption or annual exclusion, since loans are not considered gifts.
Here’s a visualization of how premium financing works.
As many as 3 documents will be needed to put the arrangement in place. An attorney should be used to draft them. The documents include: