Please see IRS Revised Regs. released February
13, 2004 for important changes to life insurance valuation.
Pension/Profit
Sharing Planning
Since qualified plan money is doubly taxed--income and estate--your
beneficiaries could end up with less than 25 percent of those assets.
If there exists $1,000,000 of pension monies, your heirs could be
left with less that $250,000. Through our “IRA Rollback”
or profit sharing technique, the following takes place:
1. There exists a current pension plan, (or a new one is established).
2. The (amended) plan purchases a large single or survivorship life
insurance policy with one or two payments.
3. A few years later, the policy is distributed to the employee
and then transferred to an Irrevocable Life Insurance Trust (ILIT),
or purchased directly by a previously established & funded life
insurance Trust.
4. The policy is reduced in a subsequent year following the 3 year
contemplation to an amount that takes into account:
_ Estate tax liquidity needed
_ Conservative interest projections
_ Desired tax leverageA Case Study
Example
Married 60 year old executive currently has $1,000,000 in a Profit
Sharing Plan.
The Profit Sharing Plan will purchase a $10,000,000 Second-to-Die
policy with a one-time premium payment of $500,000 from Profit Sharing
Plan assets. Under current assumption pricing, the policy will support
itself without additional premiums until age 100 of the younger
spouse.
Premium Paid in 2002 $500,000
Income Taxes paid in 2002 $0Policy is “rolled out” to
participant in year 3
(year 2004) with a Policy Cash Value of $227,730
Subject to 35% marginal tax rate
Total Taxes due with 2005 return $ 79,705
The policy is
then “gifted” to a properly structured Irrevocable Life
Insurance Trust (ILIT). The value of the gift trust is either the
“interpolated terminal reserve,” or the cash surrender
value. The reserve is generally higher than the cash value in the
policy. With a Universal Life chassis, some commentators believe
that the Gift Tax value is the Policy Account value, which in this
case would be $317,430. Most planners argue for using the net cash
value of $227,730 on which income tax would be paid. Seek advice
of CPA on this issue. In either instance, however, the entire amount
is less than the maximum Unified Credit amount for only one spouse
in 2004, so no Gift Tax is due, although a return should be filed.
You could also allocate the GST exemption to this for further leveraging
benefits. Policy is reduced to $6,000,000 three years later.
The client and spouse must both survive 3 years from the date of
the gift of the policy to the ILIT to have it be outside of the
estate. If both should die within the first 3 years, the proceeds
would be subject to estate taxes. Under any scenario, the client
and the heirs are always better off. Due to the income and estate
taxes due on qualified money, most advisors choose this approach,
if there is a profit sharing plan in existence. If the client needs
the profit sharing money to live on, then I would not recommend
this technique.
Alternatively, the policy can be purchased directly by the ILIT
for a 0 tax scenario. See attached DOL announcement.
Net effect
No Planning: $500,000 = $ 125,000 Heirs, $375,000 Taxes
Our Planning: $500,000 = $6,000,000 Heirs, $ 79,705 Taxes
