There are times when estate planning alone for foreigners with investments in the U.S. is not enough to eliminate any of the transfer taxes, whether they are estate, gift, or generation-skipping transfer. Sometimes the way an estate plan is designed results in high costs or complex implementation.
Life Insurance to Pay Estate Taxes Is Often the Solution
The most efficient solution to pay estate taxes in the United States has always been a life insurance policy. A life insurance policy is the ideal financial instrument because the same event that triggers the tax triggers the payment of the death benefit of the policy: to wit, the death of the insured. In addition, the fact that the death benefit is not subject to income tax for the beneficiaries, and if the life insurance policy is protected by an ILIT (Irrevocable Life Insurance Trust) this death benefit can also be excluded from the insured’s estate. All of this makes life insurance very sought out and utilized for such purposes.
Still, with the rapid increase in property and investment values of many foreigners, the amount of life insurance coverage that is required is also increasing by the day, along with the premiums needed to pay for such coverage. As a consequence, what can a foreigner do when his or her estate tax payment is projected to be in the millions at the time of his or her death?
Premium Financing Programs for Life Insurance
In principle, this type of foreign investor will require some sort of estate planning which may or may not be to his liking depending on whether he has to give up direct control of his investments or assets to unrelated third parties. Also, if the estate plan was created under civil law statutory regimes to which U.S. case law does not afford the same legal protection, or the estate plan is so complex that it requires a substantial amount of money, time, and attention from the client, it may not be effective. In these cases, we still need to answer the question posed by the title of this article: What is the best alternative solution for foreign investors who do not want to plan, or are dissatisfied with the results offered by an estate plan?
As you can imagine, the answer is life insurance. We need to add, however, that for some of these foreign investors, the complete answer is life insurance purchased through premium financing programs. Since I wrote the first article on the subject, my opinion about these programs has continued to change or evolve.
Today, I believe that premium financing is a viable alternative for people who require coverages starting at around $10 million, although the sweet spot should be around $25 million of coverage. However, due to the relative low-interest environment we now live in and the creation of new life insurance policies in the United States, foreign investors, or anybody for that matter, should not use or enter into these premium financing programs unless sufficient insurance coverage to pay for estate taxes requires more than $250,000 in annual premiums. This is true even though insurance companies today consider premium financing starting at $100,000 worth of annual premium, and interest rates vary from 2.0% and 5.35%, approximately, depending on the insurance company and the bank with which the program is established. Occasionally, insurance companies allow the insured’s bank to provide the financing.
Requirements for Premium Financing Programs
Generally, premium financing programs require not only a health evaluation but also a financial evaluation to demonstrate the need for coverage and the ability to post collateral, usually over investment portfolios or in cash during the initial years of the program. These will eventually and gradually be released, prior to the loan being repaid by the cash-value accumulated by the policy, or with funds provided by the insured. All of this would be in addition to the cash-value of the life insurance policy being pledged.
Some foreign investors end up paying 2.0% annually, for up to 15 years, on the cash-value accumulated, at which time some of it is taken out to repay the original loan by the bank. From this time, the insured or his trust becomes the only owner of the insurance policy whose beneficiaries will be able to collect upon it at his death to pay for the estate tax.
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