There’s a Hebrew proverb that says, “A good person leaves an inheritance to their children’s children…” The implicit truth here is that wise management of affairs goes beyond concern for the current generation. This wisdom of the ages should apply as well when high-net- worth clients are planning for death taxes, especially when the first generation is uninsurable!
In a nutshell, estate tax planning involves two steps: 1) implementing all workable strategies to reduce the anticipated tax bill to the lowest level, then 2) insuring against the rest with life insurance coverage on the first-generation client – usually a grandparent.
But what happens when all the gen-one clients are medical declines?
Most tax and legal advisors recommend that the best stop-gap measure against long-range depletion of the estate is insurance on the next generation (the children of gen-one) to fund any tax liability when gen-two’s net worth is passed to the third generation (the grandchildren).
The best way for gen-one to pay for coverage on gen-two may be to lend the money to the owner of the policies on gen-two – usually an irrevocable trust whose beneficiaries are gen-two and gen-three. The note held by gen-one for the loan is payable only upon the death of the gen-two insured(s) many years in the future.
This has two advantages for gen-one. First, the transaction doesn’t currently require any use of gen-one’s lifetime exemption to protect from gift taxation the money paid for premiums.
Second, down the road when the value of the note is included in the estate of gen-one at death, it could benefit from a deep valuation discount since repayment won’t occur until the death of gen-two.
Three considerations, before I get outta Dodge for the day:
This concept is often referred to as generational split dollar, or something similar. In the past it has been viewed with caution because of some unfavorable rulings. But last year the Tax Court in the case of Levine v. Comm. gave it a green light along with guidelines that serve as a virtual blueprint for attorneys drafting the arrangement. In Levine the $2,300,000 valuation of a $6,500,000 note was upheld saving the estate over $1,500,000 in estate taxes.
Financially underwriting gen-two is more complex to the extent it involves convincing the carrier of the likelihood of gen-two’s receipt of an anticipated inheritance.
Even when gen-one is insurable the concept should be considered when, for all the planning, there are still considerable death taxes anticipated at the death of gen-two.
Call with questions, material requests, or other considerations on this or any planning case you have with CPS – tom@cpsadvancedmarkets.com or 706-354-0401.