Private Financing The Perfect Hedge for Uncertain Times Presented by: Robert W. Finnegan, J.D., CLU (518) 424-8928 Funding Hierarchy (Simple to Complex) TODAY! Clients Funds Existing Funded Trusts $14,000 AGTE $5.49 Lifetime Gift & GST Transfer Assets Discounted Gift to DGT Discounted Sale to DGT Discounted GRAT (DGT) Loan Premium Structure Full Premium Split $ - Economic Ben. Private Financing Split-$ Demand Loan Pay Gift Tax (> $5.45M) OPM (Premium Financing) Commercial Lender Local Banking Relationship Bank Specialize in Premium Financing Intermediary Dual Loan For Advisor and Producer Use Only. Not For Public Distribution. 1
The Basics Private Financing (Loan Regime Split Dollar) Clients lends funds to a Dynasty Trust Defective grantor trust Trust invests loan proceeds in order to: Pay each annual premium as it becomes due Repay the loan at the end of the loan term Lump sum loan locks in current favorable 10/2017 AFRs (Nove): Short Term 1.27% ( 1.38%) 3-Years Mid-Term 1.85% (2.18%) >3-Years, 9-Years Long Term 2.50% (2.59%) > 9-years Accrue interest (powerful benefit) 2
10/2017 MidTerm AFR Private Financing - $10M SUL G Example M60/F60 Preferred 10-Pay 6% Pre-tax Return Initial: $8,668,568 Beginning of Year End of Year Life Trust End-of-Year Beginning 10 6.00% Ending Insurance Assets Loan Balance Value of Annual Pre-Tax Note Value of Death Less Loan Age 1.85% Accrued Assets Premium Earnings Repayment Assets Benefit Balance 60/60 8,828,937 8,668,568 (335,483) 499,985 0 8,833,070 10,000,000 10,004,134 61/61 8,992,272 8,833,070 (335,483) 509,855 0 9,007,443 10,000,000 10,015,171 62/62 9,158,629 9,007,443 (335,483) 520,318 0 9,192,277 10,000,000 10,033,648 63/63 9,328,064 9,192,277 (335,483) 531,408 0 9,388,202 10,000,000 10,060,138 64/64 9,500,633 9,388,202 (335,483) 543,163 0 9,595,882 10,000,000 10,095,249 Side Fund Exceeds Loan Balance 65/65 9,676,395 9,595,882 (335,483) 555,624 0 9,816,023 10,000,000 10,139,628 66/66 9,855,408 9,816,023 (335,483) 568,832 0 10,049,372 10,000,000 10,193,964 67/67 10,037,733 10,049,372 (335,483) 582,833 0 10,296,723 10,000,000 10,258,990 68/68 10,223,431 10,296,723 (335,483) 597,674 (10,223,431) 335,483 10,000,000 10,335,483 69/69 0 335,483 (335,483) 0 0 0 10,000,000 10,000,000 70/70+ 0 0 0 0 0 (0) 10,000,000 0 Grantor Repaid End of Year 9 It s Magic! *Supporting illustrations provided courtesy of Lincoln Financial Group. The Perfect Hedge 3
We have gotten lazy! 1. Taxes We have let taxes dominate our discussions. 2. Survivorship It is easier to sell to low premiums. 3. Fully Guaranteed Coverage It is easier to sell guarantees. Times are changing. We need to adjust and fine-tune our message! Threats-to-Wealth Taxes Still important to discuss, but Divorce Creditors Predators Destructive Family Dynamics Protecting beneficiaries from themselves Spendthrift beneficiary can t manage money Avoid spoiling a child with too much too soon Antisocial behavior Drugs & alcohol abuse Cults Wrong crowd Dying too soon/living too long Delaying Planning Dilution due to a growing family, inflation and taxes 4
The Perfect Planning Hedge 1.Clients retain access 2.Clients retain control & planning is flexible A. Change trust terms decanting, protectors, non-judicial settlements B. Trustees can be removed and replaced C. Control through LLCs 3.Assets are creditor protected 4.Protection against dying too soon/living too long 5.Spendthrift - Protect beneficiaries from themselves 6.Protect beneficiaries from divorce/creditors/predators 7.Protect against destructive family dynamics 8.Funding A. Self-completing regardless of tax system in place B. Funding does not trigger transfer taxes 9.Assets protected from gift, estate, GST taxes 10.Income taxes minimized and control who pays taxes. The Perfect Planning Hedge 1.Clients retain access 2.Clients retain control & planning is flexible A. Change trust terms decanting, protectors, non-judicial settlements B. Trustees can be removed and replaced C. Control through LLCs 3.Assets are creditor protected 4.Protection against dying too soon/living too long 5.Spendthrift - Protect beneficiaries from themselves 6.Protect beneficiaries from divorce/creditors/predators 7.Protect against destructive family dynamics 8.Funding A. Self-completing regardless of tax system in place B. Funding does not trigger transfer taxes 9.Assets protected from gift, estate, GST taxes 10.Income taxes minimized and control who pays taxes. Clients Beneficiaries 5
Private Financing The Perfect Strategy for the Perfect Hedge? The Perfect Strategy for the Perfect Hedge? 1. Design so that the client is fully secured - plan can be unwound at any time! a. Loaned assets + policy CSV b. The trustee can choose to repay the loan early. c. Clients can feel more comfortable entering into the transaction. 2. Moves wealth to a dynasty trust without income, gift, estate or GST taxes. 3. The DB protects against repeat estate taxation and GST taxes. 4. Not dependent upon making a gift, it is a loan. It rides out whatever tax regimen we have in place. If the gift tax comes and goes, the strategy is unaffected. 5. Income tax planning a. Income tax free benefit. b. Preserve gift/estate exemption for stepped up basis on second death. 6. Combine with Dual SLATs, BDIT, Self Settled Trusts. 7. Use any type product! Single life, survivorship, term, current assumption UL, VUL, indexed UL, WL, term 8. The strategy is simple clients understand a loan, trust investing assets. 6
Can we reduce the loan amount? Yes, of course! Extend the Premium Paying Term Extend the Loan term Switch from the midterm to the long term AFR. The arbitrage (difference between investment return and loan rate) is greater over a longer period of time (12+ years). Raise the Assumed Rate of Return Earned on Loan Proceeds (take greater investment risk) Use in kind assets. Discounts have the effect of Lowering the loan interest and Increasing the rate of return. Repay in kind (discounted). 7
For a Given DB ($10M) Longer Note & Longer Premium Paying Terms (6% Pre-Tax Return) Note Terms $10M Life Insurance *** Note October 2017 AFR Annual Years Pay Required Scenario Duration Term Rate Premium Premiums Loan 1 9 MidTerm 1.85% 335,483 10 8,668,568 2 20 Long Term 2.50% 195,840 20 4,868,500 3 30 Long Term 2.50% 146,373 30 3,364,388 4 Life Long Term 2.50% 114,608 61 2,204,799 *Supporting illustrations provided courtesy of Lincoln Financial Group. Reducing the Loan Amount The longer the loan term & premium paying term The lower the loan amount The longer the grantors must wait to be repaid 9-year note grantor repaid end of 9-years Lifetime note estate is repaid upon death (unless trust side fund outperforms expectations & loan repaid early). There are many years where the loan side fund is less than the outstanding loan balance. Upon death, some of the DB may be needed to repay the loan. Lending an amount greater than what is required Reduces the shortfall upon death. Provides a hedge if the side fund investments underperform. Look at alternate products that may have lower premiums. 8
For $10M DB Look at Different Products SUL Guaranteed v. Indexed SUL (5.72%) Term Years Guaranteed SUL Survivorship Indexed UL of to Pay Annual Amount Annual Amount Scenario Note Premiums Premium Needed Premium Needed 1 9 10 335,483 8,668,568 210,943 5,450,571 37% Less! 2 20 20 195,840 4,868,500 134,213 3,336,479 3 30 30 146,373 3,364,388 111,962 2,573,450 *Supporting illustrations provided courtesy of Lincoln Financial Group. Defined Benefit or Defined Contribution 9
Reducing the Loan Amount or Increasing the Death Benefit? Defined Benefit For a given DB ($10M) Solve for loan amount Defined Contribution: For a given loan amount ($15M) Solve for DB Defined Benefit: Given $10M DB Longer Note & Longer Premium Paying Terms (6% Pre-Tax Return) Note Terms $10M Life Insurance *** Note October 2017 AFR Annual Years Pay Required Scenario Duration Term Rate Premium Premiums Loan 1 9 MidTerm 1.85% 335,483 10 8,668,568 2 20 Long Term 2.50% 195,840 20 4,868,500 3 30 Long Term 2.50% 146,373 30 3,364,388 4 Life Long Term 2.50% 114,608 61 2,204,799 *Supporting illustrations provided courtesy of Lincoln Financial Group. 10
Defined Contribution: Given $15M Loan Amount Longer Note & Longer Premium Paying Terms (6% Pre-Tax Return) Note Terms $10M Life Insurance *** Note August 2017 AFR Annual Years Pay DB Supported Scenario Duration Term Rate Premium Premiums By $15M Loan 1 9 MidTerm 1.85% 580,386 10 $17M 2 20 Long Term 2.50% 603,187 20 $31M 3 30 Long Term 2.50% 652,824 30 $45M GSD* 4 Life Long Term 2.50% 779,334 61 $68M *Supporting illustrations provided courtesy of Lincoln Financial Group. Private Financing with Closely Held (In Kind) Assets 11
Loan of In-Kind Assets The Frazee case The grantor may lend in-kind assets to the trust. The Court stated, Nowhere does the text of section 7872 specify that section 7872 is limited to loans of money. When the trust is a defective grantor trust, the built-in gain on the in-kind loan will not be realized. Lending a client s existing brokerage account of appreciated marketable securities should be fine because those assets are easily valued and they are liquid. Loan of Hard to Value Assets A loan to the trust of an interest in real estate, a closely held business or an LLC, may be problematic because those assets are Hard to value Illiquid. The valuation risk is significant If there is a dispute with the IRS and a higher value for the loaned assets is established The loan could fail the sufficient interest test Characterized as a below market loan Create forgone interest/imputed transfer = negative gift, GST and income tax ramifications. 12
Loan of Hard to Value Assets As an alternative Client lends cash to trust. Trust pays first premium or two. Purchases business or real estate interests (discounted). Defined value clause. If cash is not available Dual Loan - Hard to Value Assets Client Borrows funds from a bank. Lends those funds to trust. Trust Pays first (and possibly second) annual premium Allows balance of loan proceeds to season for 6-18 months. Trust purchases discounted assets (qualified appraisal) from client with balance of Loan 2 proceeds. Trust now holds assets with sufficient cash flow to fund the life insurance. Client Repays the bank loan with proceeds from sale of assets to Trust. May be able to maintain the loan and invests the proceeds. 13
Dual Loan Funding of Life Insurance with Closely Held Assets Prepared by Highland Capital Brokerage (Revised: 09/21/2017) 2 Client (Grantor) Dynasty Trust Family 1. Client creates irrevocable trust. 1 Trust For the Benefit of Children, GC, GGC ii 2. Client Borrows Funds from Bank (Loan 1) i. 3. Lends those funds to Trust (Loan 2) 3 4. Uses loan proceeds purchase insurance: 5. Client repays bank loan (Loan 1) 4b a. Pay first premium. b. Purchases assets from Client. c. Cash flow from assets funds insurance. 6b. Upon death, Client s estate repaid Loan 2 proceeds plus accrued interest. 6. Upon death, a. Trust collects policy proceeds. b. Trust repays Loan 2 to Client s estate. 5 Defective Grantor Trust iii 6b Life Insurance & Other Assets in Dynasty Trust Life Insurance Income, Gift, Estate & GST tax free. Commercial Bank 4a,c 6a Insurance Co. Assets in Multi- Generation Trust For the Benefit of Children, GC, GGC Avoid Repeat Estate Taxation. Notes: i. Client posts collateral to secure bank loan (Loan 1). ii. Trustee authorized to make discretionary distributions to Children, Grandchildren, Great Grandchildren, etc. iii. As a defective grantor trust: Client pays tax on trust income and reports deductible expenses, depreciation & other tax items with respect to Trust assets. Loan interest paid or annual increase in accrued interest not income taxable. Important Caveat Not legal or tax advice or a legal or tax opinion. Any decision to implement the ideas or comments discussed herein shall be made solely by the client on the advice of his or her legal and tax advisors. Highland Capital Brokerage and its employees are not engaged in the practice of law, are not acting as legal or tax advisors to clients nor are they establishing an attorney-client relationship with the client. Dual Loan More Efficient Premium Financing 14
Dual Loan The Client, rather than the ILIT, borrows funds from a commercial lender, then loans funds to an ILIT. AFR rates apply to term loans and are substantially lower than the commercial borrowing rates The long term AFR can be locked in for many years (versus a rising commercial loan rate based on LIBOR or Prime). If structured as a demand loan (rather than a term loan), Use blended rate Currently 109 bps As a Loan Regime Split $ plan, interest can be accrued, another tremendous wealth transfer benefit. If the commercial loan is defaulted on, there is no gift to the ILIT and the Private Financing plan can continue. Dual Loan The disadvantage of this approach The grantor has to post full collateral for the commercial loan. Policy CSV cannot be used to secure the loan. Is it possible that the client could pledge the interest in the Loan Regime Split $ receivable? The clients interest in the Split $ plan is assignable (pursuant to the split $ agreement). The lender will accept the assignment as collateral. If the Split $ plan is structured as a demand loan, then upon default the lender could demand repayment. 15
Private Financing The Perfect Hedge for Uncertain Times Presented by: Robert W. Finnegan, J.D., CLU (518) 424-8928 16