1. 1 Qualified Pension Insurance Partnership (QPIP™) CWPP™ Educational Module One Hour Copyright, 2007 The Wealth Preservation Institute 3260 S. Lakeshore Dr. St. Joseph, MI 49085 269-216-9978 www.thewpi.org

2. 2 Qualified “deferred” Money: Good or Bad? For years those that make significant money have been told to defer as much as possible as a way to save taxes (PSPs, DB and 412(i) plans). Unfortunately, for clients that are 60-65 and older with estates of $4,000,000 or more, having money in a qualified plan can be a “tax trap.” IRD = income in respect to decedent and is the worst money a client can have when there is an estate tax problem. IRD will be taxed with both income and estate taxes at a clients death. Main types of IRD assets = IRAs and Pension Plan Money

3. 3 The 70% Tax Problem The IRA has $1,000,000 in it. Federal Estate Taxes at 50% would be $500,000. Federal Income Taxes would be about $400,000 but, with the deduction for Federal Estate Tax paid, the income tax is reduced to approximately $200,000. Looking at the numbers $1,000,000 Pension Plan -$500,000 Federal Estate Tax -$200,000 Income Taxes $300,000 Net to Heirs* *(does not include taxes for state income or state taxes which could increase the numbers to over 80% tax.)

4. 4 Actual Numbers IRA$1,000,000 Estate Tax: ($500,000) Assets after Estate Taxes: $500,000 (assumed at 50%) Income Taxes Federal (after deducting federal (portion of estate taxes) (35%):($217,525) State Income Taxes (5%) ($31,075) Total Taxes($748,600) TOTAL IRA ASSET AFTER TAX $251,400

5. 5 What Advice is Typically Given to Avoid Income & Estate Taxes When Dealing with Pension Plan Money? Stretch IRA (good if no estate tax issues) The sales pitch is great. –Client, would you like to turn $1,000,000 in your IRA into $16,000,000 when your 30 year old child turns 65 years old? Many clients like this sales pitch. The problem is it ignores estate taxes. A stretch can delay the income taxes due on an IRA’s distribution by using a client’s child as the “measuring” life. The problem is that a stretch will not delay estate taxes. If a client with an estate tax problem died with a $1 million in an IRA and passed that to the child via a stretch, where is the child going to find $500,000 to pay the estate taxes on the IRA?

6. 6 Stretch IRA continued Where will the child get $500,000 to pay the estate taxes on the $1,000,000 IRA? The child will take $500,000 out of the IRA to pay the estate taxes due. What happens when you take money out of an IRA? –Income taxes are due. Where does the client get the money to pay the income taxes on the money taken out of the IRA? –The child takes more money out of the IRA to pay those taxes. This creates a vicious cycle and is why stretch IRAs do not work for clients with estate tax problem. (Unless they buy life insurance to cover the estate taxes due).

7. 7 Charitable Trusts The other main way a client can avoid estate taxes on their IRA is to use charitable planning –Avoid income and estate taxes. –Only funded at death due to current income tax. –Provide benefit to others in need. –Put children in charge of trust to draw salary. –Vast amount of money, however, does not ever get to the pockets of the heirs or children.

8. 8 “Liquidate and Leverage” Liquidate and leverage is a fancy term for telling a client to take money out of a qualified plan or IRA, pay income tax on the distribution and buy life insurance to cover the inevitable income and estate taxes that will be due on the qualified asset. This strategy has a few problems. –The client then has to gift large premium payments to an IT which makes the client use up some of his/her estate tax credit or the client will have a gift tax due. –This strategy also creates a situation where the “three year look back” for gifts comes into play. Most clients are looking for a “tax favorable” way to deal with the double tax dilemma would rather not take distributions and pay tax if that can be avoided.

9. 9 Buying LI inside a qualified plan Because 412(i) defined benefit plans have become so popular, many clients are buying life insurance inside their 412(i) plans. Clients are sold life insurance in 412(i) plans because its use significantly increases the clients income tax deduction to the plan. Most clients would not buy the life insurance if they knew the negative tax consequences. Therefore, if a client has an estate tax problem, it is NOT a good idea to buy life insurance in a qualified plan.

10. 10 Continued (2 nd -to-die LI) If a profit-sharing plan buys a 2 nd –to-die policy on an employee (using the spouse as the second life), an IT can be designated as the beneficiary of that portion of the participant's account consisting of the survivorship policy. If the participant dies first, the plan can transfer ownership of the policy directly to the irrevocable trust, bypassing the participant’s estate. This would avoid income taxes on all but the cash surrender value of the policy and estate taxes would be avoided when the second spouse dies (because the policy would then be owned by an irrevocable trust). Therefore, if a client is going to buy life insurance in a qualified plan for estate tax planning, it is best to buy a 2 nd –to-die policy.

11. 11 What if a LI policy is already in a PSP or DB Plan? The client cannot roll LI to an IRA (and IRA can not own LI as an investment). The client could have the policy “distributed” at which time incomes would be due. The client could buy the policy without a taxable event. The best option is for the client to gift money to an IT and have the IT buy the policy from the qualified plan –This is the best option because there is no 3 year look back issue and –Because the DB will pass income and estate tax free to the beneficiaries.

12. 12 How is LI in a qualified plan valued? With proposed regulations issued on February 13, 2004 (Friday the 13th), the IRS in a not so clear manner indicated that the fair market value of a life policy being distributed from a qualified plan is the “premiums paid, plus investment growth on the cash value minus the mortality costs” actually charged in the policy. The regulations make little sense and hopefully clarification will be forthcoming. The valuation is NOT the cash surrender value. What a willing buyer will pay would make sense, but the regs. do not state that is the allowable value.

13. 13 What about “Pension Rescue” or IRA Rescue? Why not use the 5 pay sponge policy at AIG, Pac Life or Indy Life? –The low cash surrender value policies that could be removed from a profit sharing plan at an 80% income tax discount. Because the IRS killed the topic with the recent 412(i) regs. (Friday the 13 th, RR 2004-16) What do we tell our clients now? IRAs can not directly buy the “sponge” policy (prohibited investment).

14. 14 With a QPIP there are three participants: 1) the retirement account (IRA, PSP) 2) the participant and 3) an irrevocable trust (IT) QPIP  Willms Anderson, S.C.

15. 15 Setting up QPIP 1) An LLC is created and the majority interest in the LLC is owned by the IRA. 2) The IRA capitalizes the LLC with a one time contribution and becomes the majority investor (90%+) 2) The IT also becomes an owner in the LLC (5%). –The IT will contribute to the LLC the “costs of insurance” each year. 2) The individual client will also become a owner of the LLC (5%). –The client needs to be an owner in the LLC to create an insurable interest for the life insurance that will be purchased.

16. 16 Continued 3) After the LLC is funded, it buys a life insurance policy as one of its investments. Because the premium will be paid over a period of years, the LLC will have an investment account as well (stock and mutual funds).

17. 17 -The LLC operating agreement would dictate how much each member is obligated to contribute to the LLC toward the payment of insurance premiums, and -how the insurance proceeds collected by the LLC would be divided among the members upon the death of the insured. LLC Operating Agreement  Willms Anderson, S.C.

18. 18 Who Manages the LLC? In order for the LLC to not be considered a “disqualified person” under (which would make the balance of the IRA immediately taxable), it is imperative that the LLC not be managed by the IRA owner (and the other LLC owners should also not manage the LLC). For the QPIP to work it requires an outside party as the manager of the LLC.

19. 19 What happens at the client’s death? The IRA investor will receive back its initial investment PLUS an investment rate of return (usually pegged to the long term AFR). The client who owned a 5% interest would have typically gifted that to the children. Whoever owns that 5% interest will receive the initial investment plus an investment rate of return based on the long term AFR). The IT will receive the remaining DB. Why? Because the IT paid for the “cost of insurance” each year and therefore is entitled to the remainder.

20. 20 Buying Life Insurance in the LLC The LLC will purchase as an investment a life insurance policy. The policy will typically be a universal life policy that builds cash. The insured with be the client. The beneficiary of the policy will be the LLC. This is critical

21. 21

22. 22  Willms Anderson, S.C.

23. 23 EXAMPLE -Consider the case of Jane (age 60), a retired executive. Jane’s estate consists of her IRA ($5,000,000), cash and investments ($250,000), and her residence ($450,000). -Jane also will receive payments pursuant to a deferred compensation plan from her former company for the next 10 years that will be adequate to cover her living expenses.  Willms Anderson, S.C.

24. 24 EXAMPLE -Jane would like to leave $1,000,000 (after all taxes) to each of her three children, but also is committed to providing significant amounts to charity upon her death. -Jane’s current estate planning attorney explains that this may not be due to the taxes on the IRA at her death.  Willms Anderson, S.C.

25. 25 EXAMPLE -Jane’s life insurance advisor recommended that she buy a $3,000,000 LI policy (which should be owned by an IT) -This would allow Jane give her children a $1,000,000 DB income and estate tax free and -permit her to leave her IRA to charity.  Willms Anderson, S.C.

26. 26 EXAMPLE -Assume the premiums for Jane’s LI policy are $75,000 a year for 10 years. How can Jane pay for these premiums? -1) Simply cut the check out of assets. -2) Take taxable distributions from the IRA. -3) Used tax deferred money via a QPIP. 1) And 2) require Jane to gift the premium to an IT which will require her to use some of her lifetime gifting exemption.  Willms Anderson, S.C.

27. 27 EXAMPLE Using the QPIP -Upon establishment of the LLC, Jane’s IRA contributed securities to the LLC in exchange for a 90% ownership interest, while an irrevocable trust that Jane established received a cash gift from Jane and then contributed those funds to the LLC in exchange for a 5% ownership interest. -Finally, Jane contributed cash to the LLC in exchange for a 5% interest (which she intends to transfer to her children in the future).  Willms Anderson, S.C.

28. 28 EXAMPLE -The LLC’s investments are again expected to generate an annual return of 7%. -Based upon this level of capitalization, it is anticipated that the LLCs investments will generate sufficient earnings to fund the life insurance premiums, while still allowing the investment portfolio to remain intact.  Willms Anderson, S.C.

29. 29 EXAMPLE -Each time the LLC pays an insurance premium, an amount equal to the cost of the death benefit protection offered by the contract is charged against the capital account of the irrevocable trust. -The balance of the premium is charged against the capital accounts of the retirement account and the account owner.  Willms Anderson, S.C.

30. 30 QPIP TERMINATION -With a QPIP, the policy premiums will typically be funded on a limited pay basis. Assuming a ten-year pay policy, on or about year ten the IRA (or other retirement account) might withdraw from the LLC. After the IRA withdraws, the sole member of the LLC will be the irrevocable trust.  Willms Anderson, S.C.

31. 31 QPIP TERMINATION -While the LLC likely will have assets other than just the life insurance policy, it may not have enough assets to satisfy its obligation to the retirement account at the time of its withdrawal.  Willms Anderson, S.C. If the LLC does not have enough liquid assets to “cash out” the IRA’s LLC interest, then the LLC could borrow the funds needed to cash out the IRA.

32. 32 QPIP TERMINATION  Willms Anderson, S.C. If a loan is not possible then the LLC might issue a note payable to the IRA for the amount the IRA is entitled to upon withdrawal. At the death of the insured, the LLC could use the proceeds it collects to pay off any debt it may then owe to the retirement account.

33. 33 Estate Planning Ramifications When the death benefit pays to the irrevocable trust (which are the majority of the DBs), those proceeds will pay to the beneficiaries in an: –Income tax free –Estate tax free manner.

34. 34 What was accomplished with the QPIP? 1) We pointed out to the client with an estate tax problem how their qualified retirement plan is the worst asset in their estate (IRD). 2) We showed the client how to buy a large death benefit with pre-tax dollars. 3) We showed the client how to have that death benefit paid to the beneficiaries in an income and estate tax free manner.

35. 35 Summary The 70-80% tax problem is real, significant and getting worse as our population grows older. There are tens of thousands of clients in this country that have a $2.5 million dollar estate and $500,000 or more in an IRA. This market is going totally un-served. For advisors that know the QPIP, they will be able to help client identify the largest estate tax problem in their estate plan and bring to them a unique solution for how to mitigate the problem.