Life Insurance Planning
with “Defective Trusts”
Only the Name is “Crummey” or “Defective”
Randy Zipse, JD, CPA
Vice President & Senior Counsel
The Advanced Markets Group
John Hancock Financial Services
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Insurance products are issued by:
John Hancock Life Insurance Company (U.S.A.),
Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of
New York, Valhalla, NY 10595.
MLINY09280911598 CL DOLU092809
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
What is an Intentionally Defective Trust?
• Trust is Respected for Transfer Tax Purposes
• Trust is Ignored for Income Tax Purposes
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Grantor Pays Taxes Attributable to Trust
• Do I want to pay my kids’ tax bill?
– No, but it CAN be a good thing.
– But, be sure the client UNDERSTANDS this is how it
works.
• Rev. Rul. 2004-64, 2004-27 I.R.B. 7
– Discretionary payment of taxes by grantor NOT
additional gift to the trust.
• Trust should expressly prohibit the mandatory
reimbursement by the trust for grantor’s tax payments.
• Failure to make the repayment subject to the trustee’s
discretion invites inclusion under Sect. 2036.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Things Change
• Many of Our Clients Have Learned a Valuable Lesson
in the Past Few Years…
– Consider a provision in the trust authorizing a
termination of the “defective” characteristic.
– Some advisors comfortable with allowing an
independent trustee to have discretion to reimburse
for taxes.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Is it Totally Defective?
• Sometimes I Find “Defective Trusts” to Not Be
Totally Defective – Just a Little Bit Off
– Be careful that the trust is defective as to
income AND principal.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Defective Trust Powers
• Premium Payment Power (Sect. 677(a)(3))
– Grantor or a nonadverse party or both MAY apply trust
income to the payment of premiums on policies of
insurance on life of the grantor or grantor’s spouse.
• This power or actual payment does not cause estate tax
inclusion (See PLR 8118051 & PLR 8126047)
• WARNING!!!
> See Iversen v. Commissioner, 3 TC 756 (1944); Weil v.
Commissioner, 3 TC 579 (1944), acq. 1944 C.B. 29.
> These old cases held that only that part of the trust with
respect to which income was ACTUALLY needed to pay
premiums was a grantor trust.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Defective Trust Powers
• Power to Borrow Without Adequate Security (Sect.
675(2)&(3))
– A Grantor borrows funds from a trust without
adequate security.
• The absence of security should not cause 2036 or 2038 powers
if the trust is required to charge adequate interest.
• WARNING!!!
> See Benson v. Commissioner, 76 TC 1040 (1981)
> Bennett v. Commissioner, 79 TC 470 (1982)
> Only grantor trust as to that portion of trust borrowed – not
entire trust.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Defective Trust Powers
• NonAdverse Trustee’s Sprinkling Power (Sect. 674)
– Grantor treated as the owner of any portion of a trust in
respect of which the beneficial enjoyment of the income
or corpus therefrom is subject to a power of disposition,
exercisable by the grantor or a nonadverse party or
both.
• WARNING: The grantor needs to be careful not to directly
or indirectly control decisions of the trustee or 2036 could
cause estate inclusion. This power is sometimes limited to
trust income – thus not making the trust a grantor trust as
to corpus.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Defective Trust Powers
• NonAdverse Trustee’s Power to Add Beneficiaries
(Sect. 674(b)(5)&(6))
– Grantor treated as the owner of a trust for income tax
purposes if a nonadverse trustee has the power to add
beneficiaries (other than after-born or adopted
children).
– See PLR 200030018 (Power to Add Charitable
Beneficiary)
– Seems safe enough – if you trust the trustee!
– WARNING: What about beneficiary/trustee?
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Defective Trust Powers
• Right to Substitute Assets (Sect. 675(4))
– Retention of the right, in a non-fiduciary capacity, to
reacquire trust assets by substituting property of
equivalent value.
– WARNING: What about Sect. 2042 Incident of
Ownership when the trust owns life insurance?
• See Rev. Rul. 2008-22 (Silent as to Sect. 2042)
• What if the Sect. 675(4) carves out life insurance?
• What if the power is given to the grantor’s spouse instead
of the grantor? (Sect. 672(e)(1)(1))
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Defective Trust Powers
• Payment of Trust Income to the Grantor’s Spouse
(Sect. 677(a))
– Grantor treated as the owner of a trust for income
tax purposes if a nonadverse trustee may pay
trust income to the grantor’s spouse.
• WARNING: Grantor trust status seems to end on death of
spouse.
• ADDITIONAL WARNING: Does this only make it grantor
trust as to income and not principal?
• FURTHER WARNING: Does this discharge a support
obligation of the grantor causing it to be a deemed
distribution to the grantor? Triggering 2036 Inclusion?
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Uses of Defective Trusts
Case Study—
Mr. and Mrs. Brady
Insurance products are issued by:
John Hancock Life Insurance Company (U.S.A.),
Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of
New York, Valhalla, NY 10595.
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FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Assumptions
• Mr. and Mrs. Brady are ages 70 and 68, respectively
• They are both non-smoker standard risks
• Gross Estate $40,000,000
• Need $15,000,000 of survivorship life insurance
• They have approximately $20,000,000 of cash and
cash equivalents
• They have an S corporation worth $10,000,000
– 8% net cash flow, growing by 2% per year
– 3% underlying growth in stock
The data shown is taken from a hypothetical calculation. It assumes a hypothetical rate of return and may not be used to project or predict investment results.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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The Problem
• How to pay life insurance premiums without making
taxable gifts.
• How to transfer assets outside of taxable estate in a
tax efficient manner.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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The Solutions
Ranked by Net to Heirs
Strategy
Rank
Sale of Assets to a Grantor Trust
(15 Year Note – Long-Term AFR, May 2009 - 3.58%)
Private Split Dollar
(Non-Equity Collateral Assignment)
Private Financing Lump-Sum Loan
(9 Year Note – Mid-Term AFR, May 2009 - 2.05%)
Private Financing GRAT Exit Strategy
(9 Year Note - Mid-Term AFR, May 2009 - 2.05%)
1
2
3
4
Gifting Assets to an ILIT
5
Dual Loan Approach
6
(10 Year Note – Loan-Term AFR, May 2009 – 3.58%)
Gifting Premiums to an ILIT
7
Commercial Premium Financing
8
(10 Year Note – Loan Interest Rate 7%)
9
DO NOTHING
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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The Planning Tool Box
The Tools
• Flexible Irrevocable Life Insurance Trusts
• Irrevocable Grantor Trust
• Grantor Retained Annuity Trust (GRAT)
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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The Planning Tool Box
The Techniques
• Leveraging Annual Exclusions
• Gifting Lifetime Exemption
• Private Split Dollar
• Private Financing
• Third Party Premium Financing
• Dual Loan
• Sale to a Grantor Trust
• Exit Strategies
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Grantor Trust
• Gifts to the trust are complete for gift and estate tax
purposes (“Effective”)
• Grantor’s payment of income taxes is not a further
gift to the trust
– Rev. Rul. 2004-64
• Permits “leveraging” of trust income
• Payment of trust income can provide tax bracket
arbitrage
– Reduces grantor’s estate at income tax rates (35%)
rather than gift/estate tax rates (45%)
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Grantor Trust
• Gifts to the trust are complete for gift and estate tax
purposes (“Effective”)
• Grantor’s payment of income taxes is not a further
gift to the trust
– Rev. Rul. 2004-64
• Permits “leveraging” of trust income
• Payment of trust income can provide tax bracket
arbitrage
– Reduces grantor’s estate at income tax rates (35%)
rather than gift/estate tax rates (45%)
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Grantor Retained Annuity Trust (GRAT)
• Estate Freeze technique – in low interest rate environment
• Grantor contributes property to an irrevocable trust and retains an
annuity for a period of years
• At the end of the GRAT term, the remaining GRAT assets pass to the
remainder beneficiaries (usually the grantor’s children or a trust for
the grantor’s children)
• Goal is to completely "zero-out" the GRAT using actuarial
assumptions (Walton Case)
• Set present value of the grantor’s retained annuity equal to the fair
market value of the assets contributed to the GRAT using IRS
formulas
• Arbitrage Sect. 7520 rates
– 120% of the mid-term AFR
– 3.2% in Oct 2009
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Zeroed-Out GRAT Decision Triangle
Rate of Return
Initial Contribution
(Psychological)
•Discounts
•Increasing Annuity
ZEROED-OUT
GRAT
(Asset Choice)
•High Income/No Growth
•Good Cash Flow/Good
Growth
•All Growth/No Income
Length of GRAT Term
(Age of Client/Life Expectancy)
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Current Trends: Low Interest Rates
October AFR:
2.66% Mid-Term
LIBOR
4.10% Long Term
AFR
The AFR for an obligation is the applicable federal rate in effect under IRC Sec. 1274(d) for the day on which the
obligation is issued, as published by Internal Revenue Bulletin
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Private Split Dollar
• Non-equity Collateral Assignment Split Dollar
(NECASD) Arrangement
• Between Donor and Defective ILIT
• Very favorable economic benefit rates based on
Table 2001
• Need to roll out before equity (gain in the policy) or
first death
• Exit strategy
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Private Financing
• Use “Family Bank” - Donor lends money to ILIT
• Use current low interest applicable federal rate (AFRs)
• ILIT can either:
– Use money to fund premiums
– Invest funds and use returns to pay premiums
• Interest
– can be accrued and paid at death or
– can be paid by investment returns
• Trust income taxes paid by grantor
• Need to pay off loan before interest cost gets too high
• Exit Strategy
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Premium Financing Summary
• Loan to purchase life insurance
• Non-amortizing loan (interest only)
• Leverages insurance assets
• Many different options for third party lenders
• Dual Loan
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Premium Financing Summary
• Interest in advance (beginning of year)
• Interest in arrears (end of year)
• Deferred interest (in limited cases)
• Interest rates may be adjusted annually or may be a
fixed rate
• Size of premium usually impacts spread on interest
rate
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Sale to Intentionally Defective Grantor
Trust (IDIT)
• Donor sells property to an IDIT
• Use current low interest long-term applicable federal
rate (AFR)
• Sale ignored for income tax purposes
• No gift for gift taxes (except liquidity seed)
• Estate Freeze
• Valuation discounts available
• But no Step-up in basis at death
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Sale to Intentionally Defective Grantor
Trust (IDIT)
• Sale is ignored for income tax purposes
– Loan payments are non-taxable
– Loan payments can be used by grantor to pay income
tax liability
– No step-up in basis at death
• Income taxes paid by grantor – No additional gift
– All income from business can be used to pay premium
– Any excess income can be used to pay interest or
“amortize” note
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Sale to Intentionally Defective Grantor
Trust (IDIT)
• Need for liquidity Seed
– Rule of thumb is 10% – 20% of sale value
– Gift of business interests (with discount) or cash
– Use available “unified credit” to shelter gift
• Valuation discounts available
– FLP/LLC discounts
– Minority interest discounts
– S Corporation recaps
– Pending legislation may reduce availability of minority
interest discounts
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Grantor Retained Annuity Trust (GRAT)
• Assume GRAT investments will outperform Section 7520 rate
• GRAT remainder is transferred gift-tax free or at minimal gift
tax cost
• Valuation Discounts further enhance gift-tax leverage
• Remainder can be used to fund rollout strategy.
• Caveat – NOT a GOOD GST Leverage Technique
– Cannot apply GST exemption until the GRAT term expires
– ETIP rules
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Private Financing with a
Lump Sum Loan
Insurance products are issued by:
John Hancock Life Insurance Company (U.S.A.),
Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of
New York, Valhalla, NY 10595.
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FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Private Financing – With Lump-Sum
How It Works
Grantor loans Lump-Sum Amount
Grantor
ILIT repays loan note
ILIT Pays Premiums
ILIT
Heirs receive ILIT
proceeds
ILIT receives death proceeds
John Hancock
Life Insurance
Company
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Heirs
How It Works
Total Loan Amount = $25,236,303
Total Gifts to ILIT = $0
The Brady
Family
ILIT
Note & Loan Interest Payments
Total Premiums
$7,886,655
Outstanding Loan in
Yr. 10
$31,962,230
Death Benefit in Yr. 10
$19,337,661
Initial
Life Insurance
Death Benefit
$15,481,962
Total Trust Assets
in Yr. 15
$19,337,661
This is a supplemental illustration. Not all
benefits and values are guaranteed. The
assumptions on which the non-guaranteed
elements are based are subject to change
by the insurer. Actual results may be more
or less favorable.
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Total ILIT in Yr. 10
$19,337,661
Net To The Heirs
$19,337,661
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Private Financing with a
GRAT Exit Strategy
(Annual Loans)
Insurance products are issued by:
John Hancock Life Insurance Company (U.S.A.),
Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of
New York, Valhalla, NY 10595.
39 of 57
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Private Financing – With GRAT
How It Works
Grantor Creates GRAT
Grantor
ILIT pays loan interest
GRAT
Remainder Interest from GRAT at
the end of the term used to repay
note & future Premiums, if any
Grantor loans premiums
Insured makes gifts to
ILIT to pay loan interest
ILIT Pays Premiums
ILIT
Heirs receive ILIT
proceeds
ILIT receives death proceeds
John Hancock
Life Insurance
Company
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Heirs
How It Works
With GRAT as an Exit Strategy
Total Loan to ILIT = $7,886,657
Total Gifts to ILIT = $0
The Brady
Family
ILIT
Note & Loan Interest Payments
Total Premiums
$6,164,624
Outstanding Loan in
Yr. 10
$9,013,563
Death Benefit in Yr. 10
$19,337,661
Life Insurance
Death Benefit
$19,337,661
Total Trust Assets
in Yr. 10
$28,351,224
This is a supplemental illustration. Not all
benefits and values are guaranteed. The
assumptions on which the non-guaranteed
elements are based are subject to change
by the insurer. Actual results may be more
or less favorable.
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Total ILIT Assets in Yr. 10
$19,337,661
GRAT Remainder
Interest in Yr. 9
Net To The Heirs
$19,337,661
$9,013,563
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Sale to a Grantor Trust
Insurance products are issued by:
John Hancock Life Insurance Company (U.S.A.),
Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of
New York, Valhalla, NY 10595.
42 of 57
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Sale to a Grantor Trust
How It Works
Receives Interest
Payment on Note
Trust Pays
Insurance
Premiums
Grantor
Sales Assets & Gifts
Grantor
Trust
Life Insurance
Policy
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Current Situation
$8,291,845
of Capital Assets
and Gifts Held in Estate
Value of Capital Assets and Gifts
Year 18
$25,254,600
IRS
Estimated Taxes
Paid by Grantor
$12,627,300
Net Value to Heirs
$12,627,300
The data shown is taken from a hypothetical calculation. It assumes a hypothetical rate of return and may not be used to project or
predict investment results.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Proposed Plan – Year 18
Mr. Brady &
Mrs. Brady
$8,000,000
of Capital Assets Transferred to Grantor Trust
Interest Payments to Grantor = $3,903,200
Grantor Trust
Cash Gifts to Grantor Trust = $291,845
Promissory Note
$5,600,000
Note Repayment @ Beg.
of Year 18 $5,600,000
John Hancock
Total Insurance
Premiums Paid
$5,253,216
Value of
Capital Assets and Gifts To
Heirs
$14,906,788
Death Benefit
$15,000,000
Estimated Net
Cash Flow To
Grantor’s Estate
(EOY 17)
($2,030,239)
Net Cash Flow from Estate
$1,665,477
Total Net
to Heirs
$31,572,265
This is a supplemental illustration. Not all benefits and values are guaranteed. The assumptions on which the
non-guaranteed elements are based are subject to change by the insurer. Actual results may be more or less
favorable.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Glossary of Terms
Insurance products are issued by:
John Hancock Life Insurance Company (U.S.A.),
Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of
New York, Valhalla, NY 10595.
49 of 57
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
Glossary
• Annual Exclusion Gifts
– Under the federal gift tax, the annual exclusion is the amount that a donor can give
any individual each year without incurring a gift tax. If properly structured, these
gifts are in addition to the Gift Tax Lifetime Exclusion Amount. This amount is
adjusted each year by inflation and is per individual. For 2009, the annual exclusion
amount is set at $13,000. If a donor’s spouse agrees to be treated as having made
one-half of the gift (so-called gift-splitting) a donor can give up to $26,000 (or double
annual exclusion amount). A husband and wife, however, cannot give an individual
more than $26,000 during in any calendar year under the annual exclusion.
• Applicable Federal Rate (AFR)
– The AFR is used to determined whether a loan between related parties provides for
sufficient interest under Section 7872 of the Internal Revenue Code. AFR rates vary
depending on the term of the loan chosen. These rates are determined under Section
274(d) of the Code and are published monthly by the Internal Revenue Service and
Treasury Department.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Glossary
• Generation-Skipping Transfer Tax (GST Tax)
– The Generation-Skipping Transfer Tax (GST Tax) is federal tax imposed on a donor’s
estate when assets are transferred to lineal descendants of the donor who are two
generations (or more) below the donor or to individuals who are not the donor’s lineal
descendants but are at least 37.5 years younger than the donor. This tax is designed
to make sure that property is taxed once in each generation (i.e., to prevent donors
from “skipping” generations to avoid the federal estate tax that would otherwise apply
at each generation). Planning to avoid or minimize the GST tax is a vital component
of many estate plans for wealthy donors.
• Gift Tax Lifetime Exclusion Amount
– Under the federal gift tax, a donor can give away a certain amount of property during
life without incurring a gift tax. This amount is know as the lifetime exclusion
amount. Currently this amount is fixed at $1,000,000. If a donor’s spouse agrees to
be treated as having made one-half of the gift (so-called gift-splitting) a donor can
give up to $2,000,000 (or double the lifetime exclusion amount). A husband and
wife, however, cannot give more than $2,000,000 during their joint lifetimes.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Glossary
•
Grantor Retained Annuity Trust (GRAT)
– A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust created by a donor. The donor
transfers property to an irrevocable trust, and retains a annuity interest generally for a term of
years (the retained interest). The annuity is either a fixed dollar amount or fixed percentage
multiplied by the initial fair market value of the trust's assets. Once calculated, the annuity amount
generally remains the same throughout the term of the trust. When the trust term expires, the
retained interest ends, and the trust property (the remainder interest) passes outright to the trust
beneficiaries or is held for their benefit in the trust.
•
Grantor Trust/IDIT/Defective Trust
–
A Grantor Trust is special type of trust under Sections 671-678 of the Internal Revenue Code.
Pursuant to these provisions, the trust is ignored for federal income tax purposes and is treated as
the donor’s alter ego. As a result, the donor is required to pay income taxes on the income earned
by a the trust and transactions between the donor and the trust are not recognized for federal
income tax purposes. In other words, a donor cannot enter into a taxable transaction with his or
her grantor trust. The trust is, however, recognized for federal gift, estate, and GST tax purposes.
Usually such a trust is irrevocable and contains special provisions to make it a Grantor Trust. The
term Grantor Trust is the name given to such a trust by the Code; however, such a trust is also
know as an Intentionally Defective Irrevocable Trust (an IDIT) or simply as a Defective Trust. An
ILIT can be structured as a Grantor Trust.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Glossary
• Irrevocable Life Insurance Trust (ILIT)
– An ILIT is an irrevocable trust created during life that is designed to hold one or more
life insurance policies. An ILIT is designed to keep the proceeds from a life insurance
policy out of the donor’s taxable estate and provide beneficiaries with the means to
pay estate taxes or replace estate assets consumed by estate taxes.
• Irrevocable Trust
– An irrevocable trust is a trust that generally cannot be revoked or amended by the
donor (the person who creates the trust). An irrevocable trust can be used to
minimize or eliminate gift, estate and GST taxes. An irrevocable trust can be
established during the lifetime of the donor or upon the donor’s death pursuant to the
donor’s will.
• Liquidity Seed
– A liquidity seed is a gift to a Grantor Trust that is designed to show that the trust has
sufficient assets prior to the donor entering into a sale to a grantor trust for a note
transaction with the trust. There is no explicit requirement that a trust be seeded, but
many practitioners do so nevertheless as a precautionary step. A rule of thumb is that
a seed gift should be 10% - 20% of the expected sale price.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Glossary
• Premium Financing
– A premium financing transaction is generally a loan transaction between an ILIT and
third party lender, such as a bank. The ILIT borrows funds from the lender to pay
premiums on one or more life insurance policies owned by the trust. The life
insurance policy(ies) serve as collateral for the loans. Generally, the lender will
charge interest only during the loan term, with the principal to be repaid from the life
insurance death proceeds at death.
• Private Financing
– A private financing transaction is a loan transaction between a donor and his or her
ILIT. The ILIT is generally structured as a Grantor Trust so that the loan will be
ignored for income tax purposes but respected for gift, estate, and GST tax purposes.
The donor lends the ILIT cash with which to pay premiums on one or more insurance
policies held by the ILIT. The donor charges the ILIT AFR interest. A Private financing
transaction is designed to minimize or eliminate federal gift taxes in a situation where
the donor cannot shelter premiums with available lifetime gift tax exemption and/or
annual exclusions gifts.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Glossary
•
Private Split Dollar
– A Private Split Dollar transaction is special type of arrangement between a donor and an ILIT. The
donor pays the premium on one or more life insurance policies owned by the trust. In return for
paying the premiums, the donor or the donor’s estate is entitled to the greater of the cash surrender
value of the policy(ies) or the total amount of premiums paid by the donor, whichever is greater.
Under a Private Split Dollar arrangement, the donor is generally deemed to have made a gift to the
trust each year of the so-called economic benefit cost of the policy(ies). This value is determined by
tables and represents the Internal Revenue Service’s estimate of the value of the life insurance
protection provided to the trust each year by the donor’s premium payments. Generally speaking,
these values are very favorable as compared to AFR loan interest rates. Thus, a private split dollar
arrangement can provide significant gift-tax leverage for a donor who has very limited gifting ability
and wants to avoid a private financing arrangement.
•
Valuation Discounting
– The value of an interest in a closely held corporation, a partnership, or other asset, may qualify for a
valuation discount to reflect one or more discounts, such as a minority interest discount and a lack
of marketability discount. Total valuation discounts can range from 25%-40% of the underlying
value of the assets. Consequently, maximum leverage can be achieved with the transfer of such
interests in a gifting program.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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Disclosures
Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws
(including the generation-skipping tax). Failure to do so could result in adverse tax treatment of trust proceeds.
All examples used herein are hypothetical examples based upon hypothetical rates of return and are not indicative of past or
future results. The charts and graphs used herein are supplemental illustrations. Benefits and values are not guaranteed; the
assumptions on which they are based are subject to change by the insurer. Actual results may be more or less favorable.
Unless otherwise indicated, all values are derived from JH Illustrator and/or JH Solutions software systems. Products illustrated
are Protection SUL-G (Form: 05PR0SULG), Protection UL-G 07 and JH Survivorship UL-G.
Insurance policies and/or associated riders and features may not be available in all states.
Insurance products are issued by: John Hancock Life Insurance Company (U.S.A.), Boston, MA 02116 (not licensed in New York)
and John Hancock Life Insurance Company of New York, Valhalla, NY 10595.
All product features may not be available or may vary by state. Product availability is subject to state approval.
This material does not constitute tax, legal, or accounting advice and neither John Hancock nor any of its agents, employees
registered representatives are in the business of offering such advice. It was not intended or written for use and cannot be used
by any tax payer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or
topics it addresses. Anyone interested in these transactions or topics should seek advice based on his or her particular
circumstances from independent professional advisors.
© 2009 John Hancock. All rights reserved.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT TO BE USED WITH THE PUBLIC.
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