10/24/2016. Benefiting from Historically Low Interest Rates. Disclosure. Disclosure

Transcription

1 Benefiting from Historically Low Interest Rates This material is for continuing education training purposes only. It is not intended to be a solicitation or offer of any company's specific product or policy. CRN Disclosure The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. 2 Disclosure Distributions under the policy (including cash dividends and partial/full surrenders) are not subject to taxation up to the amount paid into the policy (cost basis). If the policy is a Modified Endowment Contract, policy loans and/or distributions are taxable to the extent of gain and are subject to a 10% tax penalty. Access to cash values through borrowing or partial surrenders will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured. Loan interest is charged when a policy loan is taken. If you take additional policy loans to pay loan interest, your policy's cash/account value will be reduced. At some point, no policy values may be available to pay additional loan interest and out of pocket payments will be required to prevent the policy from lapsing. Failure to pay out of pocket amounts will result in the loss of life insurance coverage and a tax liability in the year of lapse. 3 1

2 Agenda Interest Rate Arbitrage Opportunities Current Interest Rate Environment Compensation loans Leveraged Executive Bonus Plans Split Dollar Loan Arrangements Gift loan transactions Grantor Retained Annuity Trusts (GRAT) 4 Current Interest Rate Environment Treasury Secretary Jack Lew and Federal Reserve Chair Janet Yellen continue to make statements suggesting that interest rates will stay below normal for the foreseeable future 5 Low Interest Rate Planning Opportunities Applicable Federal Rates Rate Comparison April 2007 April 2008 April 2015 Short-term AFR 4.90% 1.85%.48% up to 3 year term loans & demand loans (see note below) Mid-term AFR (3+ to 9 years) 4.61% 2.87% 1.70% Long-term AFR (9+ years) 4.81% 4.40% 2.47% 7520 Rate 5.60% 3.40% 2.00% Demand Loans - Annual Demand Loan rate is published by the IRS each year. IRS calculates rate by adding 50% of short-term January rate and 50% of short-term July rate. For example, in 2014, the January rate was.25% and the July rate was.31%. Here are blended rates over past few years: Year Rate Year Rate % % % % % % % % 6 2

3 Loans Compensation Loans Subject to Below Market Rate rules of Internal Revenue Code (IRC) 7872 and Original Issue Discount (OID) rules of IRC 1274 Term loan should have stated interest rate at least equal to AFR at time loan entered into to avoid OID rules Demand loan at zero percent (or any rate that is less than each year s blended short-term rate) will result in taxable income Taxable income avoided with stated interest rate that is paid or accrued Below market rate loan requires annual disclosure on income tax return of employer and employee Sarbanes-Oxley restrictions limit loans to top individuals at publicly traded corporations 7 Loans Compensation Loans - Purposes Buy into business Business sells 20% of corporation stock to key employee as an interest only 20 year loan at 2.47% (April LT AFR) True compensation loan Example: Employer lends $50,000 to key employee at 1.70% interest for 9 years, lump sum due at maturity or termination if sooner Employee funds kids college education, or Employee invests funds Employee pays interest of $850 per year for 9 years, balloon payment at maturity 8 Corporate Loan to Minimize Taxes/Meet Cash Needs Using loans to minimize taxes: Client 100% owner of C Corp Client and spouse earned income $300,000 Investment / rental income 50,000 Total Income $350,000 Revised plan: Reduce compensation by $105,000 Revised earned income $195,000 Investment / rental income 50,000 Revised income $245,000 Client borrows $105,000 from C Corp Demand loan that bears interest at AFR (2014:.28%) 2014 reportable interest income will be $

4 Corporate Loan to Meet Owner/Employee s Cash Needs Revised plan: Reduce income to keep total below $245,000 Client borrows remaining cash flow need from C Corp Results of plan (assuming client has 3 Exemptions and $40,000 of deductions): Regular tax savings of $33,162 Reduced maximum tax bracket from 33% to 28% No 3.8% Medicare surtax on investments: savings of $1,900 No.9% Medicare surtax on wages: savings of $450 Note: Employee compensation deferrals still subject to Medicare payroll surtax Loan remains on books and must be dealt with at some point Loan continues to bear interest until repaid through future compensation or a dividend (taxed at 15 or 20% rate) 10 Leveraged Executive Bonus Plans Leveraged Bonus is a hybrid of Executive Bonus and Deferred Compensation Employer receives tax deduction for premiums paid on life insurance policy owned by key executive Employer provides loan to executive not to pay premiums, but to pay income tax on the amount of the bonus Employer holds a security interest in policy cash value until executive loan is repaid or forgiven Employer maintains golden handcuffs over key executive until such time as employee loan is repaid or forgiven If loan is forgiven, employee will be taxed on that loan at that point in time and may be subject to 409A rules. 11 Leveraged Executive Bonus Plans How It Works Leveraged Executive Bonus Concept Business pays premiums on a policy owned by key executive Premium is treated as taxable compensation Business deducts bonus paid from its taxable income Executive includes bonus as taxable income Business makes loan to executive to cover tax liability on bonus Loan bears interest at least equal to applicable federal rate Interest may accrue, be bonused or be paid by policy dividend* Policy is collaterally assigned to Business as security for loan repayment *Policy dividends are not guaranteed, and may not be sufficient to cover required interest 12 4

5 Leveraged Executive Bonus Plans - How It Works Repayment of Employer loan: Policy Cash Values Policy Dividends Employer Bonus Deferred Compensation (future forgiveness) Employer promise to forgive loan if Employee sticks around for x number of years Written agreement complying with IRC 409A 13 Leveraged Executive Bonus Plans The Sizzle: Employee gets life insurance policy, including source of supplemental retirement income Employee gets cash accumulation with no out of pocket expense other than interest (if not accrued and added to loan) Cash value growth compared with tax loan accrual - favorable based on current low interest rates* Employer gets current income tax deduction (for bonus, not for loan amount) Issue: Re-payment of loan out of cash values may create need for ongoing premium payments * Cash values include policy dividends which are not guaranteed 14 Leveraged Executive Bonus Plans - Crawl Out Option Cash dividends are used to help pay income tax. Reduced need for borrowing. Eventually cash dividends pay tax and help repay loan. Note Dividends are not guaranteed 15 5

6 Split Dollar Loan Arrangements Premium payments are treated as a loan Premium payor has right to recover aggregate premiums paid during life or at death Policy owner owns cash value in excess of premiums paid Policy owner s beneficiary receives income tax free death benefit in excess of premiums paid Policy loans have income and/or gift tax consequences under the below market rate loan rules Benefited party taxed on value of interest that was not required to be paid 16 Split Dollar Loans Arrangements - Advantages Employer or other premium payor Cash Values up to premiums paid are an asset of employer (premium payor) Premium payor recovers premiums paid out of policy cash values or death benefits Premium payor s share of death proceeds are income tax free Attractive fringe benefit for select employees Employee or other benefited party Generally low cost arrangement to fund personal insurance needs Transfer tax leverage taxable gift is only interest on outstanding premium loan, not the entire premium (interest can also be accrued) Applies when policy is owned by an irrevocable trust, child, or other 3rd party Income tax free death proceeds 17 Split Dollar Loan Arrangements Mechanics Loan Agreement executed Policy premiums are paid by premium payor (lender) Life insurance policy is collaterally assigned to premium payor as security for interest in policy equal to premiums paid Taxation Premiums are not tax deductible Benefited party pays interest at applicable federal rate or value of interest is taxable (income/gift, depending upon the parties involved), interest may also be accrued Taxable income if Employer/Employee Taxable gift if a private, family arrangement Each premium is treated as a new loan for tax purposes 18 6

7 Split Dollar Loan Arrangements Design Options Demand Loan Often structured as zero percent loans Annualized Short-term Applicable Federal Rate (AFR) is comparison benchmark Below market loans require disclosure on income tax return Use of Demand loans Avoids multiple term loans May avoid complex issues with stated interest rates and Original Issue Discount rules Term Loan (less common administratively cumbersome) Short Term (3 years or less) 0.48%* Mid Term (greater than 3 years to 9 years) 1.70%* Long Term (greater than 9 years) 2.47%* *April 2015 AFR 19 Split Dollar Loan Arrangement - How do Split Dollar Loans Work? When/How should loan be repaid? Repayment during lifetime from policy cash values, trust assets funded from gifts or other estate planning techniques Repayment can be made from policy s death proceeds Loan repayments from trust to grantor can be utilized to supplement grantor s retirement income As long as policy values and death benefit are growing at rate greater than loan interest rate, it is beneficial to let loan continue to accrue till death 20 Split Dollar Loan Arrangement - Private Split Dollar Loan Example ILIT owns policy ILIT Insured/Grantor/Parents Loan to ILIT Interest Payment Death proceeds equal to cumulative premium loans Premiums Insurance Company Death proceeds in excess of cumulative premium loans Proceeds held and managed for the benefit of Spouse, Children/Grand - children 21 7

8 Split Dollar Loan Arrangement - Part Gift / Part Split Dollar Loan Life insurance premiums may exceed gifting capability, but rather than doing a Split Dollar arrangement, grantor decides to lend shortfall to irrevocable trust Example, Gil, age 50 desires to purchase a whole life policy with $200,000 annual premium in ILIT Available annual exclusions total $84,000 (3 kids x $14,000 x 2) Gil will loan remaining premium to trust Premium loan will have same loan options that we ve already discussed: Demand loan with annualized short term rate used to measure required interest Term loans using mid-term rate or long term rate Remember that each new premium is a new term loan 22 Split Dollar Loan Arrangement - Part Gift / Part Split Dollar Loan Assume 15 yrs policy premiums Let s take a look at our example assuming a 3.0% interest rate over life of loan (actual interest rates will vary) Annual Accrued Cumulative Year Outlay Gift Loan Interest Loan Y/E 1 200,000 84, ,000 3, , ,000 84, ,000 6, , ,000 84, ,000 9, , ,000 84, ,000 12, , ,000 84, ,000 16, , ,000 84, ,000 34,824 1,343, ,000 84, ,000 38,836 1,498, ,000 84, ,000 42,955 1,657, ,000 84, ,000 55,980 2,160, ,000 (84,000)* 55,230 2,131, ,000 (84,000)* 54,469 2,102, ,000 (84,000)* 52,049 2,008, ,000 (84,000)* 47,568 1,835,825 *Optional 23 Split Dollar Loan Arrangement - Part Gift / Part Split Dollar Loan Assume 15 yrs policy premiums Benefits of Arrangement: Funding of life policy premiums with no current gift tax impact Payments on outstanding loan can be used to supplement Grantor s retirement income Other Considerations: Calculations on prior page assume a demand or term loan arrangement using average interest rate of 3.0% 2014 demand loan rate is.28% Parties can convert demand loan to term loan at any time to lock in a low interest rate for a period of time Higher future interest rates may require an increase in amount of interest charged Future annual exclusion increases will help to offset some interest increases Outstanding loan balance will be includable in Grantor s taxable estate 24 8

9 Loans - Gift Loans Purposes Loans to Trust or Kids to purchase assets from Donor/Lender We ll cover installment sales of assets in next presentation Loans to pay premiums on life insurance (Covered under Split Dollar Loans) Arbitrage loans Earnings can help pay life insurance premiums Example: Grantor lends $10 million to irrevocable trust at 1.70% Trust pays interest of $170,000 annually for 9 years If trust earns 5% on its investments, that s $500,000, resulting in net annual cash flow to trust of $330,000 Over 9 years, that s $2,970,000 of gift tax free cash flows into trust Grantor pays any income taxes on trust s investment earnings under grantor trust rules 25 Loans - Gift Loans Arbitrage loans Grantor lends $2 million, or $10 million, or $50 million to irrevocable trust 9 year term loans are at AFR Mid-Term Rate (1.70% April 2015) At end of loan term, loan could automatically renew for anther 9 year period, but at current interest rate Loan term could be longer (15, 20, 30 years) at AFR Long Term Rate (2.47% April 2015) Net trust earnings in excess of interest and insurance premiums can be used to pay down loan or can be invested within trust Important: Trust should contain seed money equal to 10% of amount loaned to trust Can be gifted to trust prior to loan transaction 26 Grantor Retained Annuity Trusts (GRATs) Interest leveraging estate planning technique GRATs are extremely beneficial in today s low interest rate environment Grantor transfers assets to trust scheduled to last for a fixed term of years Trust will make payments to grantor of fixed (or increasing) annual amount as set by terms of trust agreement Grantor s retained interest is valued on date of transfer to trust using IRS 7520 interest rate Retained value is subtracted from transferred value to determine amount of taxable gift At termination of trust, remaining assets are distributed to remaindermen kids or preferably grantor s ILIT This is an area where Congress has discussed making changes that could make GRATs less appealing in future 27 9

10 Grantor Retained Annuity Trusts (GRATs) - Planning Grantor Retained Annuity Trust (GRAT)- I Sec Rate (April 2015) 2.0% Pre-discounted FMV $7,500,000 Discounted Principal Transferred to Trust $5,000,000 Rate of Annuity % Amount of Payment Per Period $472, Term of Trust 12 Taxable Gift Value of Residual Interest $3.45 Hypothetical Value at Termination of GRAT with earnings 6.4 % 9% $11,572,464 Note: Illustration assumes that GRAT is funded with closely-held business assets. Hypothetical investment returns not intended to be reflective of general stock market investment returns. 28 Grantor Retained Annuity Trusts (GRATs) - Planning Grantor Retained Annuity Trust (GRAT)- II Sec Rate (April 2015) 2.0% Pre-discounted FMV $7,500,000 Discounted Principal Transferred to Trust $5,000,000 Rate of Annuity % Amount of Payment Per Period $250,000 Term of Trust 12 Taxable Gift Value of Residual Interest $2,356,175 Hypothetical Value at Termination of GRAT with earnings 6% 9% $16,059,806 Note: Illustration assumes that GRAT is funded with closely-held business assets. Hypothetical investment returns not intended to be reflective of general stock market investment returns. 29 Grantor Retained Annuity Trusts (GRATs) - Planning Grantor Retained Annuity Trust (GRAT) III Sec Rate (April 2015) 2.0% Pre-discounted FMV $7,500,000 Principal Transfer to Trust $5,000,000 Rate of Annuity % Amount of Payment Per Period $250,000 Term of Trust 8 Taxable Gift Value of Residual Interest $3,168,625 Hypothetical Value at Termination of GRAT with earnings 6% 9% $12,187,101 Note: Illustration assumes that GRAT is funded with closely-held business assets. Hypothetical investment returns not intended to be reflective of general stock market investment returns

11 Summary What We Talked About Today: Current Interest Rate Environment Compensation Loans Leveraged Executive Bonus Plans Split Dollar Loans Gift Loan transactions Grantor Retained Annuity Trusts (GRATS) 31 Action Item What Should You Do with This Information? Know that the interest rate environment impacts planning opportunities Current low interest promotes various opportunities Look for prospects and clients with estate planning needs and employee compensation opportunities 32 Questions? Any Questions? 33 11

12 2015 Massachusetts Mutual Life Insurance Company, Springfield, MA. All rights reserved. MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) and its affiliated companies and sales representatives 34 12