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PRIVATE FINANCE – The Time is NOW!

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Man with  TelescopePrivate Financing has long been a concept that estate planners have used regularly, but it has become even more popular recently. With low interest rates, transferring wealth can now be done with less capital, less cost, and less administration.

The mid-term Applicable Federal Rate (AFR) is the interest rate that applies to private financing transactions where the loan term is greater than three but no more than nine years. The rate has increased slightly from its 2012-2013 lows, but is still lower now than its historic averages1 – making now an attractive time to take advantage of wealth transfer arbitrage.

 Who might take advantage of this opportunity?

People with large estates may have a need for larger amounts of life insurance than what can be purchased with their annual exclusion gifts and they may object to the gift taxes associated with gifting the additional dollars to an Irrevocable Life Insurance Trust (ILIT)2.

Private Financing may be able to provide an alternative method for funding these annual premiums. This strategy may be considered for those who have exhausted their lifetime credit or those who want to use that lifetime credit to gift other assets.

Once an irrevocable life insurance trust is established, cash can be loaned on an annual basis or in a single sum to pay premiums. Because the loan is usually coming directly from the insured and going to his or her ILIT, collateral is not required as it would be with a commercial loan. Once the loan is made, the trust will invest the assets.

All income received over and above the required annual interest payment could be used to purchase life insurance inside the trust. This loan interest is based upon the current AFR, so the lower that rate is, the more attractive the private financing  concept becomes. This lump sum loan strategy may not work as well for individuals in their early 70s and older and will generally only be a fit for individuals with large amounts of cash at their disposal.

CoupleLet’s consider the example of a wealthy married couple who are both age 65 and healthy3.

They can set up an ILIT and seed it with a $500,000 gift4. The ILIT will then purchase a Survivorship Universal Life policy on their lives with a $5,306,479 face amount and $151,198 premium due annually for nine  years5. The ILIT borrows the premium from the Grantor for a total loan of $4.5 million. The ILIT’s annual interest payments are received income tax  free from the trust to the Grantor. With a nine year loan term, they can lock in mid-term AFR. For our example, we are assuming this to be 2%. After the term, the loan will be paid back in full.

Private Finance Chart

For appropriate individuals and families, the current environment may present an excellent opportunity to put needed insurance in place.

For more information Private Finance options, call us now at (617) 527-9736 or click here to contact us.

 


 

1 http://apps.irs.gov/app/picklist/list/federalRates.html.
2 Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including the generation skipping tax). Failure to do so could result in adverse treatment of trust proceeds.
3 Case studies are offered to show how we can provide insurance solutions in the advanced sales marketplace. Results may vary, and this example does not guarantee a similar result.
4 The interest earned inside the trust is assumed at 4.0%, a 40% estate tax rate is assumed, and 100% of the note is includible in the Grantor’s taxable estate.
5 Prudential SUL Protector, based on a 65 year old male at preferred non-tobacco and 65 year old female at preferred non-tobacco in the state of Alabama. Illustration run May 22, 2015.

 


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