Strategize with clients to minimize costs incurred with large domestic insurance policies
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Act) brought about an increase in the gift, estate and generation-skipping transfer (GST) tax exemptions to $5 million each.1 Many clients are considering creating new trusts or adding to existing trusts to take advantage of these increases.2 Some clients are also considering purchasing large amounts of insurance in trusts as a result of these increased exemptions. But with these large amounts of insurance come high insurance premiums, which could result in extremely large state premium taxes being due. Trusts and limited liability companies (LLCs) created in certain low premium tax states can be an excellent way to reduce these large state premium taxes.
Typically, a state premium tax is built into each insurance premium paid and averages 200 basis points (bps) (that is, 2 percent). These state premium taxes, however, range from a low of 8 bps (that is, 8/100ths of 1 percent) to a high of 350 bps (that is, 3.5 percent). The life insurance company pays this tax directly from the premiums paid into the policy.
As an advisor, it's important to explore various options to reduce state premium taxes and determine which strategies will work best for your client.3 Your analysis should include which types of trusts or entities to use; in which domestic jurisdiction(s) to situs those trusts or entities; and which insurance companies and policies will fit your client's needs.4
State Premium Taxes
Significantly, a few states have lowered their premium taxes to compete with the offshore insurance market. These competitive state premium taxes and modern domestic trust laws, as well as lower domestic regulatory costs and improved state consumer laws for insurance policies, have resulted in clients purchasing much larger life insurance contracts onshore versus taking the traditional offshore route. Many insurance companies have registered new policies domestically as a result of these changes, and it's important to help prospective insureds select the best onshore trust jurisdictions for their policies.5
Generally, state premium taxes are imposed on all life insurance premiums paid based upon where the applicant for the insurance policy is a resident, domicile or is sitused.6 However, an insured's resident state generally doesn't levy a premium tax on the premium paid for a life insurance policy purchased by a trust or LLC sitused in another state.7 Alaska (10 bps for premium payments in excess of $100,000),8 Illinois (50 bps),9 South Dakota (8 bps for premium payments in excess of $100,000)10 and Wyoming (75 bps)11 are the four states with the lowest premium taxes.12 (See “Where Would You Pay the Least in Premium Taxes?” p. 26.)
Domestic vs. Offshore
To put things in perspective, let's address the major types of premium taxes for both offshore and onshore policies:13
- Federal deferred acquisition cost tax (DAC tax) — The DAC tax is a one-time tax on the premiums paid into a domestic policy issued by a U.S. insurance company. A U.S. insurance company with an offshore operation (known as a 953(d) company) also pays this tax. The tax calculation is complex, but essentially equals 1 percent of the premiums. The U.S. insurance company pays this tax directly from the premiums paid into a policy.14
- Federal excise tax on foreign premiums — This is a one-time, 1 percent tax on premiums paid into an international policy issued by a foreign insurance company (called a non-953(d) company). This tax is also levied on a foreign subsidiary of a U.S. company that hasn't otherwise filed a 953(d) election (that is, filed an election to be treated as a domestic company or 953(d) company).15
- State premium tax — This tax is based on the premium dollars paid into a domestic policy issued by a U.S. insurance company. All U.S. (domestic) policies issued by U.S. insurance companies have this state premium tax.16
Note that an offshore policy must comply with all the insurance policy rules and requirements for a U.S. policy owner to defer income taxes on the inside buildup and to have the death benefit pass to the beneficiary income tax-free.17 Generally, the prospective policy owner and/or the insured signs the policy offshore (that is, they don't sign the policy in the United States).18
Consequently, offshore insurance policies issued by international insurance companies (non-953(d) companies) and U.S. companies with offshore operations (953(d) companies) aren't subject to the state premium tax.19 (See “Domestic vs. Offshore Policies,” this page.) So the decision becomes one of weighing the payment of the low state premium taxes in Alaska, Illinois, South Dakota and Wyoming (10, 50, 8 and 75 bps, respectively) with the benefit of not having to sign the application offshore and purchase the policy in an offshore trust or entity. There's also the consideration of avoiding the recent taint and reporting requirements associated with offshore trusts and products.20 Many advisors and clients have determined that the 8 bps and 10 bps state premium tax is worth the cost of having the policy purchased domestically. Additionally, many offshore policies are now being exchanged into Alaska and South Dakota trusts (as an Internal Revenue Code Section 1035 exchange, which is a tax-free exchange of a life insurance contract for another life insurance contract). Prior to the low Alaska and South Dakota premium taxes, the state premium taxes averaged 1.75 percent to 2 percent, which resulted in insureds purchasing most large policies offshore.
Choosing Insurance Companies
One important thing to keep in mind: If your client's policy is purchased by a trustee of a trust or a co-managing member of an LLC in one of the low premium tax states, make sure that the domestic insurance company will account for the low state premium taxes. Typically, many insurance companies structure their life insurance contracts using the national state premium tax average of approximately 200 bps (that is, 2 percent) and the insurance illustrations reflect this higher average. Insurance companies are allowed to do this from a product design standpoint. Some insurance companies, however, have software systems to account for the lower state premium taxes for these products, if purchased by a trust or LLC in one of the low premium tax states. They may initially balk at accounting for lower premium taxes, claiming it's a technology burden, but they generally will make the adjustment (or risk losing the insured's business to an insurance company that will recognize the low state premium tax). Generally, it's easier to recognize the lower premium tax with a private placement life insurance (PPLI)21 policy than with a standard life insurance policy; however, we've found that adjustments could be made in both instances. That's because the lower premium state tax is already built into the contract of many of the more sophisticated PPLI products.
Say there are existing trusts in another state and a client wants to purchase insurance in these trusts to take advantage of the lower premium tax in states such as Alaska or South Dakota. The client can form an Alaska or South Dakota LLC, established with Alaska or South Dakota as a co-managing member to purchase insurance within the LLC and allocate the units to the out-of-state trusts.22 These include standard fixed, variable and universal polices, as well as PPLIs. Many of the large PPLI policies are specifically structured for a particular client or group of clients and consequently provide for the lower state premium taxes of Alaska and South Dakota in the policy contracts.23 Thus, state premium tax recognition may influence which insurance companies or products are used.24
There are many types of trusts to purchase life insurance. These include dynasty, irrevocable life insurance (ILITs), revocable insurance, self-settled irrevocable trusts/domestic asset protection (DAPTs) and beneficiary defective/beneficiary controlled trusts.
Dynasty trusts — As a result of the increase in the gift and GST tax exemptions to $5 million each, this trust is one of many vehicles available to provide for the purchase of large insurance policies by families and benefit from the favorable low premium tax states. (See “How Much is Due?” this page.) The four lowest premium tax states are all dynasty trust states.25 Additionally, many clients are establishing grantor defective dynasty trusts26 and using the promissory note sale strategy27 to the trust. The promissory note sale strategy is a very powerful tool that allows for very large insurance purchases based upon an arbitrage with the note interest.
The strategy involves a promissory note sale to the defective dynasty trust and provides a great mechanism for leveraging the trust via life insurance without gift, estate or GST tax consequences. For example, assume your clients, a married couple, first make a gift of $5 million in cash or other assets to a trust that's defective for income tax purposes, but not for estate tax purposes. (See “A Powerful Funding Tool,” this page.) There's no gift tax due because the $5 million gift is more than covered by their combined gift tax exemptions (that is, $10 million). Your clients then form a family limited partnership (FLP) and contribute income-producing assets to the partnership in exchange for partnership interests. The clients sell $64.286 million in “pro rata” value worth of limited partnership (LP) interests. These LP interests are appraised at a 30 percent discount since they're minority interests and unmarketable. After taking a 30 percent discount, the LP interests that are being sold have a fair market value (FMV) of $45 million (that is, $64.286 million, discounted by 30 percent). The $5 million gift justifying a $45 million post-discount promissory note sale is based upon the 90 percent/10 percent debt/equity rules of the IRC. The sale is for 9 years, to be paid interest-only with a balloon payment at the end of the 9th year. The interest rate is 2.44 percent (the IRC Section 1274(d) federal midterm rate for May 2011). (Note that this example assumes that it costs $20,000 annually to pay the premium for each $1 million of life insurance death benefit.)
At the beginning of the first year, the trust holds assets with a value to the clients of $69.286 million, which is computed by adding the initial gift of $5 million to the pre-discounted $64.286 million in real value. The example assumes that the assets produce a 3 percent annual cash flow. Since the discount doesn't affect the cash flow, the 3 percent is multiplied by the entire $69.286 million to compute the income earned by the trust in the first year. The income earned is $2,078,580. At the end of the year, the trust must pay your clients 2.44 percent of the initial FMV of the property (that is, the discounted note amount of $45 million), or $1.098 million. This is computed by multiplying 2.44 percent by $45 million. The difference between the $2,078,580 cash flow and the $1.098 million interest payment inures to the benefit of the trust, gift and GST tax-free. This difference can be used to pay a life insurance premium without using any of the trust principal. The note interest paid to the client is income tax free, pursuant to Revenue Ruling 85-13. This is due to the fact that the trust is a grantor trust and therefore it's viewed as if the grantor is paying interest to himself, and thus, not taxed.
This strategy could produce an insurance policy with a death benefit of $49.028 million that can be purchased without any gift, estate or GST tax. Assuming the insurance contract premium rate of 200 bps (the national average), the premium tax savings for a $49.028 million policy of taking advantage of a low premium tax state could range from $12,257 to $18,827 (based on the four lowest state premium tax states). (Note that this doesn't take into account the individual insurance underwriting, which is case by case.) This is also a very powerful strategy when there's a shortage of Crummey beneficiaries or someone doesn't desire the administrative burdens of Crummey notices.
Please note, if the client dies before the promissory note term is up, the note is included in the client's estate. Sometimes term insurance is purchased for the note term to fund the taxes owed on a note or a self-canceling installment note (SCIN). The SCIN wouldn't be included in the client's estate at death, but the interest rate charged on the note would need to be slightly higher to add this feature.
An additional strategy to fund life insurance in the trust is to use the $5 million initial gift to purchase insurance and then use the cash value as a down payment for the promissory note sale strategy. The $5 million premium payment would result in more insurance, which could in turn produce additional premium tax savings by taking advantage of a low premium tax state.
One may want to consider defined value transfers as a result of the potential size of the promissory note, if the entire $5 million gift and GST tax exemptions are used. For example, assume a $5 million gift to a dynasty trust and $45 million post discount promissory note sale to a dynasty trust using an asset subject to valuation discount. This $5 million gift and $45 million promissory note sale are based upon the 90 percent/10 percent debt/equity rules, as previously discussed. Consequently, if the IRS audits the transaction and determines that the proper promissory note sale value is $55 million and not $45 million, an additional gift tax could be owed. Therefore, a defined value transfer, which expresses the transferred assets as a dollar value rather than a percentage interest or number of units, is generally used. For instance, a 99 percent non-voting interest is transferred, $X worth to a dynasty trust as a promissory note sale and the balance to a GRAT as a gift.
ILITs — An ILIT will typically be used for families that aren't interested in intergenerational planning, but are instead looking to remove the insurance policy from their estates and garner favorable lower state premium taxes.28 These trusts are usually drafted as “directed” trusts, with an investment committee given the exclusive power to both purchase and monitor the policy and underlying cash value.29 Of the four low premium tax states, South Dakota and Wyoming are directed trust states;30 Alaska has a more limited version of a directed trust statute; and Illinois has no directed trust statute.31
The one main drawback of the ILIT is that your client can't have access to the cash value during his lifetime. Thus, if you think your client may want access to the cash value for retirement or some other reason, it's best to consider other types of trusts such as a revocable insurance, self-settled or beneficiary defective/beneficiary controlled trust32 (as discussed below). However, you could suggest a dynasty trust in which your client's spouse is the trust beneficiary. This strategy would give your client/insured indirect access to the cash value via his spouse.33
Revocable insurance trusts — A revocable insurance trust, with its own tax ID number, drafted pursuant to the laws of one of the lower premium tax states and administered by a corporate trustee (or co-trustee) in one of the low premium tax states, provides the grantor/insured with access to the cash values during his lifetime by taking tax-free loans from the policies for retirement or other purposes.34 This trust structure also accommodates the family's desire to take advantage of the low premium tax laws. They're typically drafted as “directed” and use trust advisors or investment committees to assist with the selection of the proper policy, authorize the administrative directed trustee to purchase such a policy and monitor the policy.35 (See “Modern Directed Trusts,” p. 30.)
Pursuant to directed trust statutes, the trust advisor or investment committee is a party to whom certain powers are reserved by the trust instrument to the exclusion of another fiduciary acting under the instrument. Alaska has a similar type of statute.36 A trust advisor also includes any party who accepts the fiduciary's power to direct the acquisition, disposition or retention of any investment. The trust advisor may be a family member, investment advisor or insurance professional who directs the administrative trustee to purchase the insurance policy. Such trust advisors will generally be responsible for monitoring the insurance policy as well.37 They may also hire agents to assist with the monitoring.
Any trust advisor who's given authority to direct, consent to or disapprove a fiduciary's investment decision or proposed investment decision is considered a fiduciary, but not a trustee, unless the trust instrument provides otherwise. Typically, the administrative directed trustee is exonerated from the actions of the trust advisor or investment committee.38
Self-settled irrevocable insurance trusts/DAPTs — The self-settled trust is another option to provide your client with possible discretionary access to the policy's cash value.39 Self-settled trusts are frequently used as DAPTs. They're irrevocable trusts that the settlor forms for his own benefit (the settlor will be a discretionary beneficiary). The settlor can convey assets to the trust, and after the conveyance, the assets will generally be protected from lawsuits and creditors, but the settlor may have access to cash value as a discretionary beneficiary. Alaska, South Dakota and Wyoming all have self-settled trust statutes,40 but Illinois doesn't.
Beneficiary defective/beneficiary controlled trusts — Another option is to use a beneficiary defective trust in combination with life insurance.41 This type of trust is designed to give the primary beneficiary control and beneficial rights similar to outright ownership, while providing favorable tax and asset protection advantages of trusts created by another party.42 Generally, a beneficiary defective trust is one in which the beneficiary is treated as the owner for income tax purposes, but not for estate, gift or GST tax purposes.43 For example, typically, a parent would set up the trust for a child beneficiary as the primary beneficiary. The child is generally named as a co-trustee and the trust would be defective as to the child.
The beneficiary defective trust can be a funded life insurance trust that owns a life insurance policy on the life of one or more of the beneficiaries.44 In this regard, the insured beneficiary could have access to the accumulation of the life insurance income tax-free, while avoiding estate tax on the proceeds. Generally, a special trustee is used to avoid estate tax inclusion.
Reformation, Modification, Decanting
If there's an existing irrevocable trust in a high premium tax jurisdiction, it might be possible to change the situs of the trust to Alaska, South Dakota or Wyoming by naming a trustee in one of those states. Once a trustee is named in any of those three states, there's jurisdiction to either reform, modify45 or decant46 the trust based upon Alaska, South Dakota or Wyoming laws. The reformed or decanted trust would then be able to qualify for the lower premium taxes of that state, as well as the more favorable trust, asset protection and tax laws.47
Additional Favorable Laws
As previously mentioned, many states have favorable statutes that provide unique investment rules for PPLI. The IRC allows life insurance contracts to invest in a wide array of non-traditional assets.48 However, the consumer laws of most states, drafted primarily for traditionally smaller retail cases, aren't as flexible (that is, most retail variable account cases consist only of pre-packaged mutual funds). Due to very strict payment of claims periods, the current rules inherently require that all assets be liquid on a daily basis. Some state laws allow for the incorporation of certain changes in the PPLI policy contract that allow greater flexibility for investment options. Such flexibility is necessary because of the many sophisticated investment options that have certain illiquidity issues that would be in conflict with many of the current insurance code rules. For example, certain types of investments, often having minimums in the millions of dollars, only allow investors to invest and subsequently liquidate the accounts on a monthly or quarterly basis. These investments may meet the standards and provisions under the IRC, but because of consumer laws surrounding liquidation and the the insurance code provisions regarding payment of claims, these assets can't currently be held in traditional policies. There are some states that have statutes (and many other similar provisions)49 that address this issue and allow for in-kind distributions during lifetime and at death for larger PPLI policies. Additionally, some states allow for in-kind premium payments.50 One solution that insurance companies may use, when assets in separate accounts won't be immediately available for a death claim, is an amendment to the policy contract (when the policy is used) that provides for payment to the beneficiary as the underlying assets are liquidated and received by the insurance company.
- Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, Pub.L. No. 111-312, 124 Stat. 3296.
- See ibid.
- See The PPLI Solution: Delivering Wealth Accumulation, Tax Efficiency, and Asset Protection Through Private Placement Life Insurance (Kirk Loury ed. 2005).
- Ibid. On a practical note, during and after premium payments, it's recommended to leave the trust or limited liability company (LLC) in place, and not terminate the trust or LLC to avoid paying fees. Additionally, not having a trust or LLC in place during the payments of all premiums may pose a problem. On a similar note, it may be important to consider whether the state could impose a retaliatory tax. A retaliatory tax is when the state to which the premium tax is paid, charges the premium tax of the state in which the insurance company is located, if that rate is higher. States like Alaska and South Dakota directly waive the opportunity to charge such a retaliatory tax for a large case. See South Dakota Codified Laws Section 58-6-70; Alaska Statutes Section 21.09.270. We're aware of one instance in which Texas came after an Alaska insurance transaction, and the insurance company paid premium taxes of both Texas (175 basis points (bps)) and Alaska (10 bps); still lower than the normal 200 bps or more built into each policy premium.
- See Grant Markuson, Insurance as a Domestic and International Tax Planning Strategy, (Markuson and Neufeld 2001).
- See supra note 3.
- See ibid.
- Alaska Stat. Section 21.09.210.
- 215 Illinois Compiled Statutes Section 5/409.
- South Dakota Codified Laws Section 10-44-2.
- Wyoming Statutes Section 26-4-103.
- 2010 State Tax Handbook (CCH ed. 2009). Note that 100 bps equals 1 percent.
- Grant Markuson, Summary of Important Concepts and Tax Provisions for Private Placement Life Insurance (Markuson and Neufeld 2000).
- Internal Revenue Code Section 848.
- IRC Section 4371.
- Markuson, supra note 5.
- IRC Sections 7702, 7702(g), 72(e)(1) and 101(a)(1).
- Markuson, supra note 5.
- Markuson, supra note 13.
- See note 3; Markuson, supra note 13; Department of the Treasury, Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1 (FBAR form); Amendment to the Bank Secrecy Act Regulations — Reports of Foreign Financial Accounts, 76 Fed. Reg. 10,234 (Feb. 24, 2011) (to be codified 31 C.F.R. pt. 1010) (final rule that amends the Bank Secrecy Act implementing regulations regarding FBAR); Internal Revenue Service News Release IR-2011-14 (Feb. 8, 2011) (announcement regarding “a special voluntary disclosure initiative designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes”); Bank Secrecy Act, Pub. L. No. 91-508, 84 Stat. 1114-24 (1970) (codified as amended at 31 U.S.C. Sections 5311-14(e), 5316-30, 5331, 5332(2) and 12 U.S.C. Sections 1829(b) and 1951-59(e)).
- Generally, private placement life insurance (PPLI) is “a variable universal life insurance transaction that occurs within a private placement. Private placement adds the flexibility to [variable universal life insurance] product construction, pricing, and asset-management offerings. Because the product is sold through a private placement memorandum, every transaction can be individually negotiated and custom designed for the investor.” John B. Lawson, “An Introduction to PPLI,” The PPLI Solution, supra note 3; see also Mike Cohn, “Domestic Private Placement Life Insurance,” Trusts & Estates (August 2010) at p. 27.
- See note 3.
- See ibid; Markuson, supra note 13.
- This generalization is based on the authors' discussions with various domestic insurance companies and legal counsel.
- Alaska Stat. Sections 34.27.051, .100 (perpetual trust, except if trust contains a power of appointment, then the perpetuity period is 1,000 years); 765 Ill. Comp. Stat. Sections 305/3(a-5), 305/4(a)(8) (perpetual trust); S.D. Codified Laws Section 43-5-8 (perpetual trust); Wyo. Stat. Section 34-1-139 (perpetuity period 1,000 years) (respectively). See also Daniel G. Worthington and Mark Merric, “Which Situs is Best?” Trusts & Estates (January 2010) at p. 55; see also note 3.
- See Al W. King III, Pierce H. McDowell III and Steven J. Oshins, “Sale to a Defective Trust: A Life Insurance Technique,” Trusts & Estates (April 1998) at p. 35.
- See Steven J. Oshins and Kristen E. Simmons, “The SCIN-GRAT: A Hedging Technique Takes the Mortality Risk Out of Estate Planning,” Trusts & Estates (June 2008) at p. 18.
- See note 3.
- Generally, in a directed trust, the trustee has no other duty than to follow the directions of the person with the power to direct. The directed trustee has no discretionary investment duties and typically has no selection or monitoring functions, except to ensure that the grantor's intent as expressed in the trust instrument is followed. See, for example, S.D. Codified Laws Section 55-1B-1 to -11.
- Ibid; Wyo. Stat. Section 4-10-710 to 718 (respectively).
- Alaska Stat. Section 13.36.70, .75.
- See King, McDowell and Oshins, supra note 26; see also Oshins & Associates, published articles (2011), www.oshins.com.
- See supra note 3.
- See Alaska Stat. Section 13.36.70, .75; S.D. Codified Laws Section 55-1B-1 to -11; Wyo. Stat. Section 4-10-710 to 718.
- See supra note 31.
- Ibid. See supra note 35.
- See supra note 3.
- Alaska Stat. Section 34.40.110; S.D. Codified Laws Section 55-16-1 to -16; Wyo. Stat. Section 4-10-510 to -523 (respectively).
- See Richard A. Oshins and Steven J. Oshins, “Protecting & Preserving Wealth into the Next Millenium,” Trusts & Estates (September 1998) at p. 52 and Richard A. Oshins, Robert G. Alexander and Kristen E. Simmons, “The Beneficiary Defective Inheritor's Trust (‘BDIT’): Finessing the Pipe Dream,” CCH Practitioner's Strategies (November 2008), www.tax.cchgroup.com.
- See ibid.
- See ibid.
- Provided a trustee that holds all the rights and powers of the insurance policy isn't also the insured and “the insured beneficiary does not have a power of appointment over the life insurance or its proceeds.” Ibid.
- Rashad Wareh, “Trust Remodeling,” Trusts & Estates (August 2007) at p. 18. It may be helpful to reform, modify and thus modernize many existing older irrevocable trusts. Alternatively, it may be beneficial to decant from one existing older trust to a newly drafted trust, provided the trustee has the power to distribute assets. Modifications, reformations and decanting of a trust all have gained popularity as a result of modernized trust laws, changes in family circumstances and a desire to change trust administration. The ability to modify or reform the trust can generally be inserted into a trust document at its creation. Modifications may also take place without language within the trust document, if state law permits, and there's a petition to the court by trustee or majority of beneficiaries. Reformations and modifications are generally easiest when both the grantor and the beneficiaries are alive and agree with the modification. Unborn beneficiaries can generally be represented pursuant to virtual representation statutes. See S.D. Codified Laws Section 55-3-24 et seq.
- Ibid; Thomas E. Simmons, “Decanting and Its Alternatives: Remodeling and Revamping Irrevocable Trusts,” 55 S.D. L. Rev. 253 (2010). Decanting is the process of appointing trust property in favor of another trust. Some trusts give the trustees the power to decant in a trust document. A few states, like Alaska and South Dakota, have also enacted favorable decanting statutes. See Alaska Stat. Section 13.36.157; S.D. Codified Laws Sections 55-2-15 to -21. A trust generally permits trustees to pay trust principal over to one or more beneficiaries, which is called the power to invade the trust. Alaska and South Dakota's decanting statutes permit an Alaska or South Dakota trustee to pay property to another trust for a beneficiary or beneficiaries. See Alaska Stat. Section 13.36.157; S.D. Codified Laws Sections 55-2-15 to -21. Reformation and modification both result in keeping the original trust, whereas decanting results in the transfer of assets from an existing trust to a newly created Alaska or South Dakota trust. The process involves the appointment of an Alaska or South Dakota trustee to an existing trust, then the Alaska or South Dakota trustee would decant (that is, distribute trust assets) to the newly drafted Alaska or South Dakota trust. Consequently, it's important to review the trust documents to see if an Alaska or South Dakota trustee can be appointed as trustee to provide the necessary nexus to Alaska or South Dakota for the decant. Choosing the most appropriate decanting statute depends on the nature of the trustee's discretionary authority.
- See Worthington and Merric, supra note 25.
- Internal Revenue Code Section 817(d), (h).
- S.D. Codified Laws Section 58-15-17, -2 and -26.2, -33.
- S.D. Codified Laws Section 55-11-1; please note income tax consequences.
Al W. King III, far left, and Pierce H. McDowell III are the founders of South Dakota Trust Company LLC in Sioux Falls, S.D.
Domestic vs. Offshore Policies
Which premium taxes apply?
|Type of Company||Payment of Premium Tax|
| || |
| || |
| || |
— The PPLI Solution: Delivering Wealth Accumulation, Tax Efficiency, and Asset Protection Through Private Placement Life Insurance
Where Would You Pay the Least in Premium Taxes?
There's a wide range among states, with Alaska and South Dakota having the lowest basis points (bps)
|New Hampshire||125 bps|
|New Jersey||200 bps|
|New York||200 bps|
|North Carolina||190 bps|
|Rhode Island||200 bps|
|South Dakota||8 bps*|
Note: 100 bps equals 1 percent
*On premiums in excess of $100,000
— 2010 State Tax Handbook (CCH 2009 edition)
How Much is Due?
When a dynasty trust takes advantage of the increased gift and generation-skipping transfer tax exemption of $5 million, the benefits in the low premium tax states are obvious
|$5 Million Premiums|
A Powerful Funding Tool
Use a promissory note sale to a defective grantor trust to buy life insurance and avoid gift, estate or generation-skipping transfer tax exemption consequences. Here's how
Leverage a trust via large life insurance purchases based on arbitrage and note interest:
- Gift $5 million to a defective grantor trust
- Sell $64.286 million (non-discounted) family limited partnership interests to trust; discount by 30% → fair market value (FMV) = $45 million
- Trust assets equal $69.286 million (gift + pre-discounted FMV)
- Assume 3% earnings → income interest earned by trust is $2.078 million
- Federal midterm rate on 9-year note (as of May 2011) is 2.44% → note sale interest payment = $1.098 million paid out to grantor
- Compute difference in earnings: $2.078 million less $1.098 million = $980,580 → difference can be used to buy life insurance without using any trust principal
- Assume $20,000 premium per $1 million death benefit
- Trust can buy $49.028 million life insurance policy
— Based on Steven J. Oshins, Al W. King III and Pierce H. McDowell III, “Sale to a Defective Trust: A Life Insurance Technique,” Trusts & Estates (April 1998) at p. 35