Along with most careful financial advisers, we resist tax-driven business decisions. Instead, we encourage our clients to make sound economic decisions, and then we cautiously help them identify and implement those tax-sensitive steps which are most likely to save them money. Our view is that "aggressive" tax planning (read: "risky" tax planning) is rarely, if ever, in a client's best interest.
We do watch the passing parade of tax strategies du jour with great interest. And we pride ourselves on our ability to introduce cutting-edge ideas into our recommendations where we think they make sense. We've even had a hand in developing some innovative approaches which have been widely adopted by our colleagues.
We're taking this issue of "The Lane Report" to share with you a very sophisticated tax-saving idea which, although clearly not a "magic bullet" for every high-income taxpayer, demonstrates the evolution of the creative planner's thinking. What's more, it offers a cornucopia of tax tidbits for you to savor.
The strategy is called "Foreign Variable Universal Life insurance", and it combines the tax benefits of trusts, life insurance ownership and offshore planning.
An almost real-life case study should help you understand how FVUL is supposed to work.
Take Happy Harry. He's 50 years old and is selling his stock, which cost him only $10,000 15 years ago, for $2 million. After Harry pays a 30 per cent Federal and state capital gain tax, he'll net just under $1.4 million. If he can earn 12 per cent annually (or 8.4 per cent, after taxes), his principal will grow to $7.4 million in 20 years. If Harry dies at age 70, his heirs will net $3.3 million, assuming a 55 per cent Federal estate tax.
But suppose Harry, understanding all the risks, opts instead for a FVUL. If all goes as planned, he'll avoid any capital gain tax on his $2 million sale. And his 12 per cent annual return won't be subject to income tax, either. So, his principal will grow to a whopping $21.7 million - and never be subject to any Federal estate tax!
Here's how it's done.
First, Harry transfers his stock to an irrevocable U. S. trust, which names Harry's kids as beneficiaries. This is a strategy we frequently recommend to keep life insurance proceeds or other assets out of a client's taxable estate, and it does a very good job of it.
Harry's irrevocable trust then sets up another trust, a "foreign asset protection trust," outside the U.S., as the name implies. The beneficiary of the foreign trust is the domestic trust Harry set up first. This is pretty fancy, but less exotic than it sounds; offshore trusts are often used to hold assets and shield them from the claims of creditors.
Next, the foreign trust sells Harry's stock and buys a Foreign Variable Universal Life insurance policy with the proceeds. Universal life insurance is a popular, tax-sheltered way to grow "cash value" and, with it, wealth. Variable universal life insurance takes the opportunity one step further by allowing a policy's cash value to be deployed among mutual fund-like subaccounts. Not surprisingly, the policy's design is subject to all kinds of U.S. tax rules, and foreign policies are subject to additional technical requirements of their own.
Although FVUL assets should be held in a "segregated account," there is always the risk that Harry's kids may never see his money. Offshore insurance companies aren't regulated by U.S. insurance commissioners and simply might walk away from their obligations or go broke. So, Harry will be well advised to insist on proof that his insurance company's policies are "reinsured" with a stable and healthy "reinsurer." He should also confirm that his insurer holds policy assets in a custodial account at a major bank.
FVUL's aren't for the faint of heart. Yet, Harry's example is instructive. And even the risk-averse may benefit from the linkage of ostensibly unrelated tax strategies.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.