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Life Insurance Planning in a
Low Interest Rate Environment
Asset Sale to a Defective Trust
Presented by:
0259913-00001-00 Ed. 04/2014 Exp. 10/07/2015
INSURANCE PRODUCTS:
NOT INSURED BY FDIC OR ANY MAY LOSE NOT A DEPOSIT OF OR GUARANTEED FDIC BANK
FEDERAL GOVERNMENT AGENCY
VALUE
BY ANY BANK OR ANY BANK AFFILIATE
Introduction
• Why are interest rates so low?
• What may cause rates to rise?
• How can low rates help with HNW planning?
Why low interest rates?
• Economy is in recovery mode
• Low interest rates => households, businesses
spend, invest more
• More spending, investing => employment
growth, rising GDP
The Recovery Cycle – At a Glance
New Demand
for Goods,
Services
Low Fed
Rates
Low
Lending
Rates
Spending,
Investment
Recovery
Employment,
GDP
Consumer,
Investor
Confidence
Why could rates rise?
• The Good: Increased consumer, investor
demand for credit vs. limited lending capital
• The Bad: Rising inflation
• The Ugly: U.S. debt ratings downgrade
Long-Term Growth – At a Glance
Low Fed
Rates
Low
Lending
Rates
Recovery:
Sustained
Demand for
Credit
Fed
Relaxes
Target
Rising
Treasury
Yields
Impact of Rising Treasury Yields
Treasury yields determine the AFR (borrowing)
and § 7520 (discounting) rates for individual
taxpayers
Treasury
Yields
AFR
§ 7520
The Planning Benefits of Low Rates
• Lower interest rates make some wealth transfer
strategies more efficient:
– Interest-only borrowing
– Sale of property where buyer has limited ability to pay
– Valuing a donor’s retained interest in property
Profile – Sale to Defective Trust
• Works in low rate environment because:
– Asset purchases financed at a low rate allows more asset income
to be used for other purposes
• For individual clients who…
 Own large income producing assets
 Income is in excess of their current lifestyle need
 Are interested in leveraging the income and lifetime gift-tax
exemption amounts for the benefit of heirs
 Who have a life insurance need where the premium is in excess
of their willingness or capacity to gift
 Are able to pay income taxes on trust income using personal
funds
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Hypothetical Example
Case Study
• Married clients, both age 72, have a $10 million municipal
bond portfolio paying 4.55% interest and $7 million dollars
of other assets
– They do not need the bond income for living expenses
– The potential estate tax liability on the bonds is $4,000,000
– Unspent Interest income will increase the size of the taxable estate
• Clients understand the possible estate tax exposure and
are looking for help
This hypothetical example is for illustrative purposes only. Actual results will vary.
How Does
Step 1it–Work?
Create a Trust
• Step 1:
– Attorney creates “Intentionally Defective Trust (IDT)”
• The client will be the “grantor” of the trust
– What is an “intentionally defective trust?”
- The trust terms cause the grantor to remain responsible for
tax on trust income even though the trust corpus is outside
the grantor’s estate
- All items of income and deduction are attributed back to
grantor
Attorney
Drafts IDT
IDT
How Does
it Work?
Step
2 - Sale to IDIT
• Step 2:
– Client “seeds” trust with $1,000,000 (gift)*
– Seed money is either/both a present interest gift (eligible for
annual exclusion) or requires use of lifetime exemption
Grantor
$1,000,000
IDT
IDT
*There may be federal gift tax consequences associated with the funding of an Irrevocable Life Insurance Trust.
How Does
it Work?
Step
3 - The LLC
• Step 3:
– Client transfers bond portfolio into an LLC (or
partnership)
• The LLC creates flexibility because the underlying LLC
interests can change hands multiple times by gift or sale
without changing title to the bonds
Bond Portfolio
Grantor
LLC
LLC
How Does
it Work?
Step
3 - The LLC
• Step 4:
– Client sells LLC assets to the IDT
• No capital gains
• Income tax attributable to trust income is paid by the grantor
LLC
LLC
IDT
Grantor
Promissory
Note
How5Does
it Work?Life Insurance
Step
– Introducing
• Steps 5 and 6:
– Cash flow from LLC assets pays note interest; excess for 9
years can be used to purchase life insurance
• Bond portfolio yields $455,000 annually at 4.55%
• $184,000 note interest due annually to grantor at 1.84% (3/14 mid-term AFR)
• Remainder of $271,000 sufficient to purchase approximately $6,100,000 of guaranteed
survivorship universal life insurance (9 Pay)
– Can pay off part of the debt if the client dies prematurely
– Can pay any federal estate taxes, prevent a forced sale of the assets upon death
Grantor
$184,000
IDT
IDT
$271,000
Insurance
Policy
$6,100,000
Death Benefit
How Does
Stepit 6Work?
- Repayment
• Step 7:
– At the end of the 9th year the note is due and the trustee
pays off the note (in kind) with the LLC interests.
• Repayment of principal is not a taxable event
• Client then owns the LLC, which owns the bond portfolio
• IDT has the paid-up guaranteed death benefit
LLC
Grantor
IDT with
$6,100,000
Paid-Up
Insurance
Policy
IDT
$6,100,000 Insurance
Policy (Paid Up)
The Big Picture
Grantor
4
3
7
AssetNoteLLC
2
Sale of LLC in
exchange for a
$10MM
promissory note
Nine $184k
Interest
Payments @
1.84% AFR
$1,000,000
Seed Gift
Repayment of
$10MM @ end
of year 9
5
IDT
Economic Substance
4
LLC
1
Attorney
Drafts IDT
7
6
$6,121,959 Death
Benefit
PruLife SUL Protector with a
guaranteed lifetime death benefit - Male and Female A72, PNT
- 9 payments of $271,000
Benefits
Results
Benefits:
• Clients effectively receive $184,000 of their bond interest
for the next 9 years
• Excess cash flow was leveraged into life insurance to
provide the estate with liquidity for the eventual estate
taxes
• LLC with bond portfolio was returned to the client at the
end of the 9 year period
• Any income taxes due on trust income were paid by the
grantor, bestowing the trust with a significant economic
benefit while making no actual gift
Getting Started
Talking Points
• Do you know what some of the benefits low interest rates
could have for your wealth transfer planning?
• Are you aware of the factors that may bring the economy
out of this low interest rate environment?
• “We don’t want to give up control of our assets.”
• If you could find ways to minimize the loss of control over
your assets, would you be interested in knowing more?
• Let me share an idea with you…
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NOT FOR CONSUMER USE
Next Steps
• Individual meeting
Clients Who May Benefit
• Identify prospects
 High Net Worth ($10MM+) and family
oriented
 Are concerned about the impact of transfer
taxes on their financial legacy
• Build and present case
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NOT FOR CONSUMER USE
 Have sufficient income from other sources,
besides the assets used in the strategies
What’s In It For You?
• Enter the advanced planning club.
• Help clients to take action now.
• Preserve and/or increase assets under management (AUM).
• Support and Resources
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NOT FOR CONSUMER USE
Summary
Why These Strategies, Why Now
• Taking advantage of low interest rates using the strategy described
here could help to enhance wealth for heirs.
Why Life Insurance
• Life insurance is essential in managing the risks inherent in the
strategy, and may also further enhance the amount of wealth going to
heirs.
Getting Started
• Implementing the strategy using simple talking points and our
resources
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NOT FOR CONSUMER USE
Important Considerations
Before implementing this strategy
• Clients should consider developing a comprehensive financial plan to take into account
current and future income and expenses in conjunction with implementing any of the
strategies discussed here.
• We recommend that clients consult their tax and legal advisors to discuss their situation
before implementing any strategy discussed here.
About these concepts
• This concept is only suited to high net worth clients who do not rely on the assets for living
expenses for the expected lifetime of the insured(s). It is the client’s responsibility to
estimate these needs and expenses and it is recommended that they consider developing
a comprehensive financial plan in conjunction with implementing the strategy being
considered. The accuracy of determining future needs and expenses is more critical for
clients at older ages who have less opportunity to replace assets used for the strategy.
If your client’s financial or legacy planning situation changes
• If clients need to use the assets or income in the strategy for current or future income
needs and they can no longer make premium payments, the life insurance death benefit
may terminate and the results illustrated may not be achieved.
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Important Considerations
Tax and other financial implications
• There may be tax and other financial implications as a result of liquidating assets within an
investment portfolio. If contemplating such a strategy, it is important for clients to
understand that life insurance is a long-term strategy to meeting particular needs.
About life insurance
• The death benefit protection offered by a life insurance policy can be a key component of
a sound financial plan. It is important for clients to fully understand the terms and
conditions of any financial product before purchasing it.
Other notes
• Clients should consider that life insurance policies contain fees and expenses, including
cost of insurance, administrative fees, premium loads, surrender charges, and other
charges or fees that will impact policy values.
• If premiums and/or performance are insufficient over time, the policy could lapse, which
would require additional out-of-pocket premiums to keep it in force.
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Important Information
This material has been prepared by The Prudential Insurance Company of America to assist financial
professionals. It is designed to provide general information in regard to the subject matter covered. It should be
used with the understanding that we are not rendering legal, accounting or tax advice. Such services should be
provided by the client’s own advisors. Accordingly, any information in this document cannot be used by any
taxpayer for purposes of avoiding penalties under the Internal Revenue Code.
PruLife® SUL Protector is issued by Pruco Life Insurance Company, except in New York where, it is issued by
Pruco Life Insurance Company of New Jersey. Both are Prudential Financial companies located in Newark, NJ.
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NOT FOR CONSUMER USE
Thank You