The Cross Endorsement Buy Sell ADVISOR COMPANION

Transcription

1 The Cross Endorsement Buy Sell ADVISOR COMPANION BUSINESS PLANNING A unique buy-sell plan where the owner and the insured are the same Most buy-sell plans funded with life insurance have one thing in common: the life insurance is typically owned by someone other than the client their partners, their business or another entity. The cross endorsement buy-sell plan is a unique type of buy-sell arrangement that allows clients to fulfill their obligations under a cross-purchase buy-sell plan while still owning their own policy. What It Is A cross endorsement buy-sell arrangement is an alternative to the typical funding approach used with cross-purchase buy-sell agreements. Instead of each owner buying a life insurance policy on the lives of the co-owners, each owner purchases and owns a policy on his/her own life and endorses some or all of the death benefit to the other business owners to satisfy obligations under the buy-sell agreement. In return for the policy owner endorsing death benefit to his/her co-owners, the other owners will each pay an annual rental fee equal to the economic benefit costs of the endorsed amounts, Economic Benefit Rates: The calculation of the annual economic benefit generally involves the use of the government s Table 2001 rates, or the insurer s alternative term rates, whichever are lower. 1 similar to the economic benefit fees charged under a split dollar arrangement. When a policy owner dies, his or her co-owners will receive the portion of death benefit endorsed in their favor and will use those funds to meet the purchase obligations under the cross-purchase buy-sell agreement. Any death benefit not endorsed to the co-owners will be paid to the owner s designated beneficiaries (e.g. spouse and children). How It Works BUSINESS OWNER A Endorses Death Benefit Pays Rental Charge BUSINESS OWNER B Endorses Death Benefit Pays Rental Charge LIFE /17 PAGE 1 OF 7

2 Key Benefits 1. Personal ownership: If and when your client severs his/her relationship with the business (due to retirement, sale of business, or some other type of separation), client simply continues to own his/her life insurance policy. Upon separation, your client can terminate the endorsement on the policy and is free to use the policy, and any accumulated cash value, for his or her own benefit. There is no need to swap or sell policies among business owners at the death or separation of a business owner from the business. 2. Product Selection: The client has control over what type of policy to purchase. Your client may choose a policy that is low cost, with cash value growth a secondary consideration. Alternatively, your client may prefer to pay a higher premium to fund an accumulation type policy, such as a VUL or IUL product, to increase cash value in the contract. Especially when the buy-sell is no longer needed, your client can use available cash value for their own personal reasons such as to supplement retirement income, college funding, etc. Notably, the client may also be able to use the cash value to buy out another partner for example, in the event of partner s retirement. It is important to note that term insurance is not used with a cross endorsement buy-sell. 3. Multi-Purpose Policy: The client can cover both personal and business needs with one life policy. If your client has personal insurance needs beyond the buy-sell arrangement, such needs can be combined in one policy. For example, assume your client, Mary, needs $1M of death benefit for buy-sell funding purposes but also needs $500k of coverage for her personal insurance needs. By implementing a cross endorsement buy-sell plan, Mary can purchase a $1.5M policy and endorse $1M of death benefit to her co-owners to fulfill her buy-sell obligation while retaining $500k for personal planning. This type of arrangement can add both simplicity and flexibility to help the client meet his/her business and personal needs and goals. 4. Ease of Administration: A cross endorsement arrangement offers many of the same benefits of a cross-purchase arrangement with fewer policies required. A cross endorsement buy-sell arrangement is an alternative method to fund a cross-purchase buy-sell obligation and may help limit the number of policies that must be purchased. For example, in a traditional cross-purchase arrangement, each business owner buys a policy on the other owners which means, if there are three business owners, six policies must be purchased. In comparison, the cross endorsement method would allow each business owner to purchase one policy and endorse death benefit to as many other business owners as necessary. PAGE 2 OF 7

3 HYPOTHETICAL EXAMPLE Jim, age 47, and Ron, age 49, are 50/50 owners of a business that is valued at $1M. Jim and Ron enter into a cross endorsement buy-sell arrangement. Under this arrangement, they will each rent to each other death benefit in the amount of $500,000 for the duration of the buy-sell plan. Jim decides to purchase an additional $250,000 of death benefit for personal needs, for a total of $750,000. Ron decides to overfund the premium on his life insurance policy, which has death benefit in the amount of $500, Jim Jim and Ron enter into a cross-endorsement buy-sell arrangement where they agree to buy one another out upon a triggering event such as death, disability or retirement. The buy-sell agreement is a binding legal obligation. Ron Jim purchases a JH life insurance policy on his life Death benefit = $750,000 ($250,000 extra DB needed for Jim s personal needs) Annual premium = $10,774 2 Ron purchases a JH life insurance policy on his life Death benefit = $500,000 Annual premium = $16,781 Policy overfunded for supplemental retirement income Jim endorses $500,000 of the insurance policy on his life to Ron 3 Ron endorses the full $500,000 insurance policy on his life to Jim Jim pays economic benefit rental charge annually to Ron for the rental of Ron s death benefit Jim receives rental charges from Ron for the rental of Jim s policy to Ron. See Figure 1 on page 4 for what the numbers look like over a 16-year period 4 Ron pays economic benefit rental charge to Jim annually for the rental of Jim s death benefit Ron receives rental charges from Jim for the rental of Ron s policy to Jim. See Figure 2 on page 4 for what the numbers look like over a 16-year period For the next 16 years, Jim and Ron both have death benefit coverage to satisfy their buy-sell obligation WHAT S NEXT If there is no triggering event during the buy-sell period, Jim now owns his own policy Jim also has an additional $250k death benefit for his own personal planning needs WHAT S NEXT If there is no triggering event during the buy-sell period, Ron now owns his own policy Starting at age 65, Ron can now access policy cash values for supplemental retirement income needs PAGE 3 OF 7

4 FIGURE 1 - JIM 16 year Rental Charges collected by Jim from Ron; 16 year Rental Charges Paid to Ron by Jim. FIGURE 2 - RON 16 year Rental Charges collected by Ron from Jim; 16 year Rental Charges Paid to Jim by Ron. YEAR RENTAL CHARGES COLLECTED FROM RON RENTAL CHARGE PAID TO RON 1 $330 $370 2 $350 $395 3 $370 $420 4 $395 $445 5 $420 $475 6 $445 $505 7 $475 $540 8 $505 $585 9 $540 $ $585 $ $650 $ $725 $ $800 $ $885 $1, $970 $1, $1,055 $1,265 YEAR RENTAL CHARGES COLLECTED FROM JIM RENTAL CHARGE PAID TO JIM 1 $370 $330 2 $395 $350 3 $420 $370 4 $445 $395 5 $475 $420 6 $505 $445 7 $540 $475 8 $585 $505 9 $650 $ $725 $ $800 $ $885 $ $970 $ $1,055 $ $1,155 $ $1,265 $1,055 Case Summary As you can see from the above example, under the cross-endorsement plan, Jim and Ron are able to satisfy both their buy-sell needs as well as their personal planning needs with one policy. What s more, the cross-endorsement structure afforded them simplicity and flexibility in a tax-efficient manner. The cross endorsement structure afforded these clients the simplicity and flexibility they needed in a tax-efficient manner. Jim Ron PAGE 4 OF 7

5 What Sets John Hancock Apart COMPREHENSIVE PORTFOLIO OF PRODUCTS John Hancock offers your clients multiple product choices that can be used to fund their cross endorsement buy-sell needs. Whether they are looking for cash accumulation or low cost death benefit protection, we have a product solution to meet any need. THE POWER OF VITALITY The John Hancock Vitality solution is now available on a wide array of our competitive suite of products. Your clients can significantly reduce their premium or enhance their retirement income potential, while also earning valuable rewards and discounts by living a healthy life. The John Hancock Vitality solution rewards healthy living and offers your clients personalized health goals, simple tips, and a complimentary Fitbit device to track their progress. By leading a healthy lifestyle, such as by exercising regularly, clients can earn points which can be applied for valuable entertainment, shopping and travel rewards and discounts. Moreover, for certain types of policies, as clients health progresses, the points they earn could translate to even greater income potential. While any permanent life insurance product may be able to help your client get the most out of his or her cross endorsement buy-sell, only a John Hancock policy with the Vitality Program gives them something more. LIFE AND LONG-TERM CARE John Hancock s Long-Term Care (LTC) Rider allows clients to accelerate their policy s death benefit to cover qualified long-term care expenses. To the extent the policy is not used to pay long-term care expenses, any residual death benefit is paid to the named beneficiaries at the insured s death. This rider offers clients a unique mix of coverage, experience, and tax efficiency unmatched by the competition. Note: It s important to consider how the LTC rider impacts the life insurance death benefit being endorsed to a co-owner pursuant to a cross endorsement buy-sell agreement. For example, the parties may want to limit use of the LTC rider while the buy-sell arrangement is applicable, or allow access only to the extent there is death benefit not being endorsed to another co-owner. Benefits of Using Life Insurance Flexibility. Permanent insurance provides the flexibility needed to transition the business and use the life insurance policy based on an owner s changing needs over his/her life span. Estate liquidity. Cash is available from the life insurance proceeds for the efficient transfer of the business due to an owner s death, retirement, or sale of the business. Potential cash values. Unlike a term insurance policy, the potential accumulation of the life insurance policy s cash values can be used to accommodate a lifetime buy-out or to supplement income when the buy-sell obligation is no longer required. The Vitality Program can be used to earn valuable rewards and discounts, in addition to reducing the premium or enhancing the cash value potential. Long-Term Care rider can be added to provide LTC benefits if needed. PAGE 5 OF 7

6 Important Considerations Transfer-For-Value: Under Internal Revenue Code ( IRC ) section 101(a)(2), the transfer of a life insurance contract or any interest in the contract for valuable consideration can result in a portion of the death benefit being subject to income tax, unless an exception to the transfer-for-value rule applies. Exceptions to the transfer-for-value rule include a transfer to (1) the insured, (2) a partner of the insured, (3) a partnership in which the insured is a partner, or (4) a corporation in which the insured is a shareholder or officer. To avoid adverse tax results under the transfer-for-value rules, the cross endorsement buy-sell arrangement may not be appropriate for owners of a C or S corporation, unless one of the exceptions to the rule can be met. For example, if the shareholders of an S corporation also own a separate business taxed as a partnership, the exception for transfers to a partner of the insured should be met to avoid a transfer-for-value issue. 2 Income Taxation: Although similar to an endorsement split dollar arrangement, this arrangement may not meet the split dollar requirements articulated in Treas. Reg or Treas. Reg in all instances. For example, the split dollar regulations do not appear to cover an endorsement arrangement whereby an individual is endorsing 100% of the death benefit to another individual. However, general income tax principles should apply to the renting of the death benefit between the policy owner and the business owners receiving the endorsed death benefits. To determine the rental charge associated with the death benefit being endorsed, a strong argument can be made that the economic benefit rates associated with split dollar arrangements (e.g. Table 2001 rates or the carrier s alternative term rates) are still appropriate to determine the value of the insurance that is being rented year-to-year under this arrangement. 3 The rental of annual death benefit by the policy owner to the other parties to the arrangement also may result in taxable income to the policy owner. At a minimum, the rental income recognized by the policy owner each year should be equal to the economic benefit costs associated with the endorsement. If the economic benefit amount is not paid (or otherwise recognized by the policy owner), the death benefit endorsed to a co-owner may not receive 100% income-tax free treatment. 4 Estate Taxation: The insured s personal ownership of the policy under a cross endorsement arrangement will likely cause inclusion of the insurance proceeds in the insured s gross estate under IRC However, the estate may qualify to receive a deduction under IRC 2053(a)(4) for the liability established under the endorsement arrangement, which contractually requires the policy owner to endorse the death benefit to the other business owners under the Buy-Sell Agreement and this Cross-Endorsement Agreement. To the extent that the death benefit on the policy may exceed the amount being endorsed, the insured may want to consider ownership of the policy in an irrevocable life insurance trust ( ILIT ) in order to exclude the balance of the death benefit from inclusion in the insured s taxable estate. The client should consult their legal/tax advisors for advice on these matters. For more information on the application of the transfer for value rules, see our BYA: Understanding Transfer-for-Value or call Advanced Markets. PAGE 6 OF 7

7 1. An insurer s alternative term rates can be used only if the insurance company issuing the policy meets certain requirements outlined in IRS Notice See PLR and PLR (Transfers to shareholders who are partners, even though in an unrelated partnership, fall within one of the exceptions to the transfer for value rule). 3. See, e.g. Treas. Regs (d)(3), Treas. Reg (b), and Notice Cf. Treas. Reg (f)(3) (stating that proceeds are received income-tax free to the extent the cost of insurance was paid for by the non-owner under a split dollar agreement). For agent use only. This material may not be used with the public. This material was not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Anyone interested in these transactions or topics should seek advice based on their particular circumstances from independent professional advisors. Life insurance death benefit proceeds are generally excludable from the beneficiary s gross income for income tax purposes. There are few exceptions such as when a life insurance policy has been transferred for valuable consideration. Loans and withdrawals will reduce the death benefit, cash surrender value, and may cause the policy to lapse. Lapse or surrender of a policy with a loan may cause the recognition of taxable income. Policies classified as modified endowment contracts may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age 59 1/2. The Long-Term Care (LTC) rider is an accelerated death benefit rider and may not be considered long-term care insurance in some states. There are additional costs associated with this rider. The Maximum Monthly Benefit Amount is $50,000. When the death benefit is accelerated for long-term care expenses it is reduced dollar for dollar, and the cash value is reduced proportionately. Please go to to verify state availability. Vitality is the provider of the John Hancock Vitality Program in connection with policies issued by John Hancock. Enhanced income potential will apply based on the Status attained by the life insured. In New York, entertainment, shopping, and travel rewards are not available and are replaced by healthy living and active lifestyle rewards. Vitality is the provider of the John Hancock Vitality Program in connection with policies issued by John Hancock. Rewards may vary based on the type of insurance policy purchased for the insured (Vitality Program Member) and the state where the insurance policy was issued. John Hancock Vitality Program rewards and discounts are only available to the person insured under the eligible life insurance policy. Rewards and discounts are subject to change and are not guaranteed to remain the same for the life of the policy. Insurance policies and/or associated riders and features may not be available in all states. Insurance products are issued by: John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in New York) and John Hancock Life Insurance Company of New York, Valhalla, NY John Hancock. All rights reserved. MLINY PAGE 7 OF 7