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LIFE

When The Estate Tax Window

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 included two years of higher federal estate, gift and generation-skipping transfer (GST) tax exemptions; portability; and lower tax rates for transfers made at death or during an individual's lifetime. The act reunifies the three exemptions at $5 million per individual and $10 million per couple, and reinstitutes stepped up basis. The act sets a top estate, gift and GST tax rate of 35 percent, equaling the lowest rate in recent history. In addition, the act provides that any unused portion of the $5 million available exemption at a spouse's death would be eligible to be carried over to the surviving spouse.

The federal estate tax has been a chess game between both political parties since the enactment of the 2001 tax provisions. Many doubt whether there will ever be "permanent" reform. This act does not provide long-term comfort. Remember - it's the estate tax law in effect when the individual dies that counts. When evaluating the "political risk" involved in delaying planning beyond this two-year window, consider also that the cost of the tax relief in the act is estimated at $858 billion by the Congressional Budget Office. This cost may impede future efforts to make the act's changes permanent. Unless further legislative action is taken, the exemptions and rates that went into effect on Jan.1 will boomerang back to their 2001 limits of $1 million and generally 55 percent beginning on Jan.1, 2013.

If the clients' goals include protecting and passing on wealth to their family, then instead of waiting for Congress to create permanent estate tax legislation, they should consider taking back control of their estate planning, transcend the politics and take positive action that protects their family and their overall wealth - for the long term.

So, 2011 and the so-called "two-year window" present advisors with new and old planning opportunities: new opportunities based on the provisions of the act and old opportunities where an advisor can review in-force coverage for a client and perhaps "supersize" or "right size" the policy and the program.

New: Planning opportunities

As noted, the current lifetime gift exemption is at an all-time high of $5 million per individual, enabling significant gift-tax-free transfers during 2011 and 2012. Clients should consider gifting $5 million to an irrevocable life insurance trust (ILIT) and enhancing this legacy through the purchase of life insurance. Add a long-term care rider to supercharge this idea.

Ultimate product flexibility

It is doubtful, at least in the short term, that there will be "permanent" estate tax reform. New and innovative products address this issue. These products provide an option to purchase additional death benefit if estate tax exemptions fall and tax rates rise, and, alternatively, provide high early cash values allowing for almost total refunds if exemptions rise and rates fall. These products solve the "deer in the headlight" problem when clients will not act due to uncertainty.

Trust opportunities

During this window, large gifts to dynasty and spousal access trusts may be appropriate. Likewise, gifts and sales to grantor trusts, with easier seeding due to the increased gift tax exemption, have the potential to remove significant amounts of wealth from taxable estates. In addition, this major increase in the gifting exemption may also allow for more funding of already-established intentionally defective grantor trusts and beneficiary-defective grantor trusts. This may be a good time to reexamine these installed techniques and see if they might benefit from increased funding to give greater financial substance to the arrangements.

First: A brief word about policy reviews

Clients and advisors have heard, and hopefully heeded, the need for a policy review-and not just one review once, but every few years over the lifetime of the policy-to measure actual policy performance against original expectations. A policy review will help determine if a policy is on track to reach the original goals of the policyholder. A thorough policy review will include a detailed policy analysis and should include (for example) a review of credited interest rates, dividend scales, mortality and expense charges; the insurance carrier's financial condition; changes in the policy owner's financial condition or need for insurance; and changes in the insured's health or lifestyle.

The review should be based on the up to 600 pieces of policy information that can be gathered directly from the insurance carrier. Further, an overall performance and risk rating should be applied, as well as an outline of necessary action items. Finally, a comparable profile should be prepared, if warranted, to provide an analysis of alternatives to the current insurance arrangement.

Second: Program reviews

How can the good news contained in the act be used in a program review? Let's consider an advisor who worked with a client several years ago on a private financing arrangement for a large life insurance policy. Here are the facts: Mr. Client made a lump sum loan, in 2007, of $5.1 million to a grantor ILIT. The terms of the note were: 15 years, 4.81 percent interest using the long-term AFR and deferred interest. The trust-side fund was illustrated to grow at 7 percent. The loan was sufficient to purchase an SUL-G policy on a 15-pay basis with an annual premium of $189,580, resulting in a $15 million death benefit. The trust would accumulate excess income to generate a side fund to repay the note in 15 years. Note assets would return to the grantor's taxable estate. However, Mr. Client really needed $35 million of death benefit but did not have enough liquidity to loan the funds needed to support a $35 million policy. The note balance is approximately $6.2 million.

In a post-act world, what can be done? Forgive a portion of the note, refinance the balance and leverage the interest savings.

Using the higher $5 million gift exemption, Mr. Client forgave $4 million of the note. He then refinanced the balance using a nine-year note at the midterm AFR of 1.95 percent, saving the trust-side fund more than $240,000 annual compounded interest. The trust then purchased an additional $21.6 million policy for $232,246 annually using the amount of interest saved in the gift/refinance transaction. The total premium on the new total death benefit of $36,622,461 will be an annual premium for the next 11 years of $421,826 and an annual premium thereafter of $232,246. In year-14, the trust-side fund (again illustrated at 7 percent) will be sufficient to repay the outstanding loan of $2.6 million.

Net result: Mr. Client purchased the full $35 million (and then some!) of death benefit needed without any additional cash outlay.

The bottom line? The act gives advisors lots of reasons to reach out and consult with old and new clients. There is lots of good news for clients on both the product side and the transaction side, but you have to act fast-2013 is a mere 19 months away.

Gene Marks owns The Marks Group, a 10-person technology consulting firm that specializes in Customer Relationship Management (CRM) products like GoldMine and Microsoft CRM. He also writes monthly online columns for Forbes and Business Week magazines. [email protected].


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