Creating Value for Clients with ILITs - a Team Approach An ILIT For All Seasons January 25, 2011 Bill Conway & Lou Shuntich 1

Fundamental Principle Estate planning is not just about saving taxes. Rather, it is about taking care of yourself and your family and then with proper planning doing it at the lowest tax cost possible. 2

Putting Things In Perspective The increase in the Estate Tax Applicable Exclusion Amount to $5 million has significantly decreased the number of clients who need to be concerned about estate taxes Yet, based on 2001 information American families with a net worth of more than $10 million numbered 338,400* In addition, There are over 6 million U.S. households with a net worth of $1 million to $5 million** LSI Estate Planning Newsletter #1729 (December 13, 2010) AT **January 2009 Journal of financial Service Professionals 3

The Problem = Constant Change The increase in the Estate Tax Applicable Exclusion only applies to 2011 and 2012 with no certainty as to what the future holds This presents a need for flexibility in planning so that clients can be responsive to changes in the transfer tax laws while attending to their personal and financial needs 4

Estate Tax Reducing Techniques Two common threads: –You must change how you own or manage your property –You must make substantial gifts to the next generation Problem: –As people grow older they do not like change –Making large gifts can make them feel financially vulnerable 5

The ILIT Alternative Purchase life insurance to cover needs and taxes through an Irrevocable Life Insurance Trust (ILIT): Customers do not have to change their lives and may go on living as they always have 6

Avoiding Estate Tax Inclusion The prospective insured must be willing to give up control of the life insurance to keep the death proceeds out of their gross estate under IRC § 2042 The coverage must be purchased and owned by a third party –Family member: no certainty that the proceeds will be used as intended –ILIT: The terms of the trust control the use of the death proceeds 7

$5 Million Gift tax Exclusion The 2010 tax act creates a 2 year window of opportunity to make a $5 million gift tax and GST tax free transfer to an ILIT –The gift may be in cash to pay premiums, or –It may be a gift of income producing property that will generate income to pay premiums or for other purposes –If the ILIT is structured as a grantor trust the ILITs earnings will compound income tax free 8

Drafting to Provide Liquidity Trustee is authorized to lend to the estate Trustee is authorized to purchase assets from estate Wealth Docs includes these provisions 9

Drafting ILITs Individual or Joint Grantors Family (mirror RLT Bypass Trust) Divorce or Annulment Provision Life Insurance Provisions –Authorization to invest in life insurance polices –Investment in off shore insurance –Use of income to purchase insurance 10

Drafting for Indirect Access Loans to grantor –Trustee borrows against policy and re- loans –If adequately documented and secured, should be no incident of ownership –No taxable income – trust is grantor trust under IRC 675(3) –Note plus accrued interest is debt against estate 11

Drafting for Indirect Access Inter-vivos Bypass Trust (Family Bank Trust/BERT) –Spouse has access –Income taxable to grantor (payable on joint 1040) –Not included in spouse’s estate –At spouse’s death (LPA?) –Danger is reciprocal trust doctrine Self-Settled Trust Jurisdictions 12

“Family Bank Trust” Create as a grantor trust; Sell appreciated assets tax-free; Remove assets + future appreciation from gross estate; Grantor pays any income tax liability created by income from trust assets; Trust appreciates in value undiminished by income taxes; Trust distributions are later made to the beneficiaries free of gift and estate tax. 13

Other ILIT Advantages Besides providing funds for federal estate tax liquidity an ILIT can address other personal and financial needs of the grantor’s family including: –Creditor protection –Special needs children –Educational needs –Wealth replacement –Multi generational management of assets –Non-tax estate liquidity needs 14

Creditor Protection A ILIT can be designed to protect beneficiaries who can not handle money Beneficiary’s creditors can not reach assets in the trust Creditors can reach funds given to the beneficiary Solution: The trustee purchases goods and services for the beneficiary 15

Special Needs Children A properly drafted ILIT may be used to benefit a special needs child without causing a loss of government needs based benefits (most importantly Medicaid) This may be accomplished by including language in the trust that subjects any payments for the child’s benefit to the trustee’s sole discretion. 16

Estate Liquidity Needs Payment of Federal and state income taxes due on IRA, 401K Plans State Estate Taxes Mortgages, car loans, personal loans and credit cards Estate administrative fees 17

Funding Educational Needs The cost of higher education has escalated dramatically A ILIT can be used to provide grants to trust beneficiaries for college, graduate school or specialized training –Cash value during the insured’s life if other sources of funds are unavailable –Death proceeds after the insured’s death 18

Wealth Replacement Individuals thinking about making charitable gifts especially of taxable IRA, 401K type assets can replace a part of their inheritance Individuals can replace the value of property through life insurance held in an ILIT for multiple generations of their family Instead of receiving real property and the problems that may go with it the children will receive cash (income tax free) 19

Multi-Generational Management Of Assets Many states have changed the rules limiting how long trusts may last. Trusts may now be sited in jurisdictions that will benefit multiple generations as a form of family bank for medical, educational and other needs. An opportunity for the advisor team to work with the family for multiple generations. 20

Amending Existing ILITs Sale of trust assets to new trust Assignment of trust property by Trust Protector/Trustee Trust Decanting Trust Protector Merger 21

Existing ILITs Trust owned Life Insurance (TOLI) Most TOLI has no servicing producer Most professional trustees have no guidelines for handling TOLI or making asset allocations on Variable Universal Life (VUL) policies Most non-professional trustees have not reviewed their policies in the last 5 years and have no procedures for asset allocation on VUL policies Asset allocation does not assure a profit or protect against a loss in a declining market. 22

Policy Audits Life insurance whether individually owned or trust owned should be regularly reviewed from two perspectives: –Is the policy appropriate to current needs? –Is the policy performing as originally illustrated? 23

Is the policy performing as originally illustrated? Separate account products –During the 1970s companies developed products that placed investment decisions and risk in the hands of policyholders –Cash values and death benefits are tied to the selected investments’ performance Guarantees are based on the claims-paying ability of the issuing insurance company. 24

Original assumptions, still apply? During the mid-80s some UL policies were illustrated at 12% or higher Current lower crediting rates mean that many policies will not perform as illustrated Some companies have raised the cost of insurance Lower dividend scales require more term in blended arrangements to maintain total death benefits 25

Performing the Analysis Request an in-force ledger and using the: –c urrent premium –current interest rate –current insurance charges, and –current policy values Illustrate values to determine if the policy will perform as originally illustrated, and Determine will the policy perform as currently needed? 26

Remedial Choices – Old Policy Keep the policy as is – may lapse Increase premiums Reduce the face amount Surrender or replace the policy Utilize non-forfeiture values Sell the policy Note: These choices entail diverse tax consequences that the policy owner should take into account. 27

New Policy Considerations New types of policies, options, riders and guarantees may be available to improve the policyholders situation Improvements in underwriting, expense management and life expectancy may mitigate in the policyholders favor –Same face, lower premium –Higher face, same premium Guarantees are based on the claims-paying ability of the issuing insurance company. 28

Replacement - if the existing coverage should be replaced consider Tax consequences Surrender charges New contestability periods Insured’s health Changes in the insured’s tobacco use, occupation and hobbies (Under most circumstances, a policy owner is best advised to follow IRC Section 1035 rules when replacing a policy.) 29

Questions? 30