Saturday, July 4, 2015

Tax Secrets: Why do the rich buy so much life insurance?

The answer: Favorable tax law makes life insurance tax-free. This law gives everyone, but mostly the rich — who are always in the highest income tax and estate tax brackets — an easy way to create more wealth. Tax-free. No risk. Guaranteed!
Is $1 million a lot of money?
Can you guess how many dollars you must earn to leave your family $1 million?
Try this:
  • You must earn $2.78 million.
  • Less income tax (state/federal) on $2.78 million at 40 percent: $1.11 million.
  • Balance: $1.67 million
  • Less estate tax on $1.67 million at 40 percent: $.67 million
  • Balance to family $1 million
A lousy deal: The tax collector gets $1.78 million (64 percent) and your family only $1 million (36 percent).
The tax law allows you to perform magic tax tricks
1. Insurance premiums are deductible for estate tax purposes
For example, suppose you pay a total of $500,000 in premiums on a $2 million dollar policy. The $500,000 is gone, it can’t be taxed by the estate tax monster. Result: For a net $300,000 cost ($500,000 premium less $200,000 of estate tax saved) your family gets $2 million tax-free (guaranteed) — a great tax-advantaged investment.
2. At death
A. So we have a $2 million death benefit, with a premium cost of $500,000, leaving an excess of $1.5 million, which is a clear profit. Yes, this profit is tax-free; no income tax.
B. The $2 million death benefit is structured (easy to do) to be estate tax-free.
3. And even after death
Say you die with a $10 million policy on your life owned by an irrevocable life insurance trust (ILIT) and your wife is beneficiary. No estate tax at your death.
Your wife dies many years later — the amount in the ILIT has grown to $12 million. Every penny of that $12 million will pass to her heirs (probably your kids and grandkids) tax-free. No estate tax. No income tax.
Three little-known strategies to enrich your heirs, while avoiding the estate tax monster.
Following are three (actual cases from my private client files) strategies used many times in real life. Read carefully. Chances are you’ll see an opportunity.
1. Funds in a qualified plan (like a 401(k) or IRA)
Sadly, funds in a qualified plan are double taxed (income and estate tax). This strategy, Retirement Plan Rescue (RPR), turns the tables on the IRS.
Example: Sam, married to Sue, has $900,000 in an IRA. Using a RPR to purchase a $5 million second-to-die policy avoids every penny of the estate tax. WOW! $900,000 (only $324,000 after the double tax) turns into $5 million (tax-free).
2. Existing life insurance policies with a cash surrender (CSV)
Frank had a second-to-die policy (insuring him and his wife Faye and owned by an ILIT), acquired in 1996 with a current CSV of $850,000 and a death benefit of $1.53 million. We did a tax-free exchange raising the death benefit to $3.48 million. No out-of-pocket cost to Frank, Faye or the ILIT. Do you have a CSV policy that is 8 years old or older? You must take a look at this strategy.
3. The annuity strategy
This two-step real-life example is a jaw dropper.
Step No. 1. Matt (married to May) bought an immediate joint life annuity for $1 million (will pay $43,843 every year for as long as either Matt or May is alive).
Step No. 2. The after-tax amount of the annuity will pay the premium on a $5.68 million second-to-die policy on their life. Everything — the annuity and death benefit — is guaranteed.
Remember the after-estate tax-value of $1 million is only $600,000. So Matt turned $600,000 into $5.68 million — guaranteed. And tax-free. Smart planning, Matt!