While we advise our clients on protection insurance coverage, most of our practice involves the use of life insurance for purposes other than protection planning. We’re either building wealth for retirement and living benefits, utilizing the product’s cash value, or preserving and transferring wealth through the death benefit. Here is a small collection of our favorite uses of life insurance:


As An Asset Class For Wealth Transfer

When acquired for purposes of transferring wealth inter-generationally, the life insurance death benefit is unique. Products available today will guarantee the death benefit when one dies such that the resulting internal rate of return (IRR) to the estate, assuming normal life expectancy, is between 6 percent and 7 percent. Recognizing that this is an income-tax-free return (and if properly structured, should also be free of estate taxes), it is hard to conceive of any other product in this low-yield market environment, with the same exceptionally low level of risk, producing a similar return.


As a Wealth-Replacement Trust

Appreciated assets, when liquidated, are usually subject to capital-gains taxes. For very high-income-tax payers (especially those living in high-income-tax states like California), the combined federal and state capital-gains tax rate can be in excess of 35 percent. One technique often employed by high-net-worth (HNW) individuals is the transfer of appreciated assets to a charity through a device known as a Charitable Remainder Trust (CRT).


Prior to the sale of the assets, they are transferred to the CRT, and once in the CRT, they are liquidated for their fair market value. Because they are now contained inside the CRT, the assets are not subject to any capitalgains tax. Hence, the sale proceeds are then reinvested in (usually) income-producing assets, which will generate significantly more income than if the donor had liquidated the assets while personally owning them.


The CRT allows the donor to control the assets during his or her lifetime, and, subject to some strict IRS rules, allows the donor to receive the income from the assets (and potentially some of the principal, too).


Additionally, the donor receives an immediate tax deduction for the present value of the assets ultimately left in the CRT and transferred to the charity at the donor’s estimated demise. The impact of the tax deduction and the additional income received during the donor’s lifetime can be substantial, but ultimately, the remaining assets in the trust must be "lost" to the donor’s heirs.


Very typically, a small portion of the additional income and/or the savings from the tax deduction is sufficient to allow the donor to acquire a life insurance policy (usually established such that it is free of estate taxes as well as income taxes) to fully replace the assets that would have gone to the donor’s heirs, but are now going to the charity. This is known as a Wealth Replacement Trust, and when used with a CRT, is perhaps one of the most effective "triple pays" available: tax reduction, charitable giving and wealth transfer.


As An Estate-Reduction Technique

Wouldn’t it be great if ultra-high net-worth parents could make loans to their kids prior to their deaths, and when they die, have these long-term, interest-only loans discounted in their estate, thus lowering the taxable value of the estate for purposes of calculating estate taxes? Unfortunately, the IRS does not allow for any discounts on loans to related parties.


Or does it? If the loan is made directly to an insurance carrier for the purpose of buying life insurance under a special so-called "split-dollar agreement" on another individual, and the loan is still outstanding at the time of the lender’s death, can the loan be discounted for purposes of the estate valuation? The answer is yes, and here’s how it works. The kids buy large life insurance policies on themselves funded with loans from Mom and/or Dad. These loans are made subject to a minimum interest rate set by the federal government and known as the Applicable Federal Rate (AFR).



The AFR has three rates: short, mid and long-term (more than nine years), and changes monthly. Under these arrangements, the long-term rate is used to calculate the minimum required interest on the loan, and the loan is to be repaid to the parents from the death benefit at the time of the insured kid’s death, invariably many years after the parents have passed away. Given the relatively low AFR – in February 2017, when this article was written, the rate was 2.81 percent – and the estimated number of years to the time of death and repayment of the loan to the parents’ estate, valuation professionals will take discounts to reduce the value of the loan, and if reasonable, the IRS will accept the valuation discount.


As A "Golden Handcuff"

Many organizations are continually looking for ways to retain and reward key management executives. The use of qualified plans for many organizations is usually insufficient to incent highly-compensated key employees to remain with the entity. Hence, the use of "non-qualified" plans has become common with highly successful businesses as a retention tool. These plans are collectively called "non-qualified," as they do not need to meet the stringent qualification standards set by the IRS in order to obtain a current tax deduction for the contributions. Instead, they can be designed for just a few select employees, have no limits on contributions, rules on vesting, or timing of withdrawals, and not be subject to any penalties for violating the qualified plan rules.


Essentially, the plan has two components: the agreement between the employer and employee, and the "informal" funding mechanism, almost always a specially engineered life insurance plan. The agreement will provide the terms under which benefits will be paid to the employee and usually contain terms that relate to years of service (handcuff) before the employee is entitled to the "pot of gold."

The life insurance policy is designed to have sufficient cash at the time the employee fully vests under the agreement, and will also provide a death benefit in the event the employee dies prematurely. Most agreements include a provision whereby the employee’s spouse or family will receive the fully vested benefit if the employee were to die prior to the end of the service term.


As A Specialized Retirement Plan

There is a little-known executive- retirement strategy that has been employed for a number of years and recently received national attention. In its technical form, the strategy is known as Employer Split Dollar and has components that are similar to the family split-dollar plan mentioned earlier. Under this plan, the business organization makes interest-free, non-recourse loans to the employee via contributions to a specially engineered life insurance policy owned by the employee.


Because the loan is interest-free, it is handled under the "below-market interest" rules of IRC Sec. 7872, whereby interest must be imputed on the loan using the Long-Term AFR, as previously discussed. In this case, the employee is "charged" the interest as non-cash compensation from the employer, and must pay income taxes on the imputed amount. While the employee remains employed, arrangements can be made between the employer and employee as to how the tax on the imputed interest can be funded.


At retirement, the employee can withdraw tax-free distributions from the policy to both pay the tax on the imputed interest and for (usually substantial) additional retirement benefits. The only caveat is that cash withdrawals must be limited in order to maintain sufficient value in the policy death benefit to repay the "split dollar" component, i.e., the loan payments, back to the organization at the time of death of the employee.

Richard Myerson, CPA, CLU, ChFC, is President and CEO of The Myerson Agency. He formed The Myerson Agency in 1994, with a focus on engineering specially designed life insurance products, primarily aimed at tax reduction, wealth preservation and wealth accumulation. 


David Szeremet, JD, CLU, ChFC, is second vice president, Advanced Planning, at Ohio National Financial Services based in Cincinnati, Ohio. Szeremet is responsible for the Advanced Planning team that provides estate planning, executive benefits, business insurance and life insurance planning. He can be reached at david_szeremet@ohionational.com or at 513.794.6389.


This article appeared in Advsior Today.