Employer Owned Life Insurance

The Pension Protection Act of 2006 (PPA) covered many subjects, but perhaps one of the most important dealt with “COLI Best Practices”. COLI of course stands for Corporate Owned Life Insurance, but a more generic and informative reference would be to EOLI, or Employer Owned Life Insurance. The basic rule under the PPA, which added Section 101(j) to the Internal Revenue Code, applicable to policies issued after August 17, 2006, is that the proceeds of EOLI are taxable income to the extent they exceed premiums paid; fortunately, however, there are exceptions to this basic rule that apply to the types of transactions which you, our advisors, typically handle for your clients, specifically, policies insuring the business owners themselves and/or their key employees. However, in order to activate these exceptions and keep the life insurance proceeds income tax-free, the principal new requirement is that the insured’s consent must be obtained in writing before any application is taken. In addition, pursuant to IRC Section 60391, a simple informational tax form, Form 8925, must be filed annually with the employer’s federal tax return as long as any such policies remain in force.

Coincidentally, the IRS recently released Notice 2009-48 (the Notice) which provided guidance as to several aspects of the new requirements. Most matters covered in the Notice are straightforward and do not contain any surprises. However, applicable to those situations where post August 17, 2006, policies may have been put in force without complying with these new requirements, a very brief window has been provided for correcting this deficiency. In essence, the Notice states that the IRS will not challenge a taxpayer who made a good faith effort to comply with the new requirements by June 15, 2009, exactly one week from today.

Just about every carrier has its own suggested form for obtaining the insured’s consent, offered as a supplement to its basic application package, but Provada has also developed a form that we can supply upon request.

Please contact us at 415-369-9990, ext 116, or bob@provada.com, for more information.

Failing Life Insurance Policies

With the recent steep stock market decline and steadily reducing interest rates over the past 20-25 years, both variable and non-variable life insurance policies have been negatively impacted, and many are underperforming seriously enough to be on the road to an early demise.  This is  particularly true of those policies that were underfunded because the premiums were based on unrealistically high illustrated stock market rates of return or unrealistically high assumed ongoing interest rates.  Unfortunately, many, if not most, policyowners are totally unaware of this impending disaster.  This problem is highlighted in the Wall Street Journal article published on May 26^th titled “Keep Tabs on Insurance That Covers Estate Tax.”

To find the best solution for your clients to this serious situation, we urge you to use Provada’s comprehensive Personal Policy Review program.  Under this program, we carefully analyze inforce policies, look at alternatives, and make appropriate recommendations.  In some cases, often depending on the client’s current state of health, the client is better off keeping the inforce policy; in other situations, implementing a Section 1035 tax-free exchange to a new policy best serves the client’s objectives; and in still other situations, a life settlement may be in order, either because the insurance coverage is no longer needed or where the net proceeds serve as the seed money for a new policy.

Do not delay.  Look through your client base, select the clients who may be most in need of a Policy Review, and let us know if you have any questions. We’re here to help.

More on the Taxation of Life Settlements

Since my prior post, many professional commentators have expressed their opinions regarding the most important (and unfortunately adverse) holding in Rev. Rul. 2009-13: the required adjustment to basis that must be made when a policyowner sells a policy under a life settlement transaction, namely, that the “cost of insurance” charges must be subtracted from premiums paid. Since these “cost of insurance” charges have already been subtracted internally in determining the policy’s cash value, this appears to be the equivalent of a double subtraction of the same amounts, especially since the policy’s cash value is an important determinant of the purchase price a purchaser is willing to pay, because it directly affects the future premium payments required to maintain the policy.

Many commentators agree, then, that this is a very controversial holding, and I personally believe it might well be successfully challenged in court. However, I do not think any of us would encourage any of our own clients to be the guinea pig who challenges the IRS … unless, of course, a large amount of money is at stake, which might be the case if long-term capital gain rates are increased in the future. Even now, if the policy being sold is a rated policy, the actual “cost of insurance” charges will be significantly higher, meaning (if actual charges are the correct method of calculating “cost of insurance” for this purpose) a larger amount will need to be subtracted in determining adjusted basis, leading to a larger amount being subject to tax as a capital gain.

RIGHT NOW, HOWEVER, PERHAPS THE MOST IMPORTANT MESSAGE TO KEEP IN MIND IS AS FOLLOWS: THIS HOLDING WILL NOT BE APPLIED ADVERSELY TO SALES OCCURRING BEFORE AUGUST 26, 2009. THIS MEANS THAT, IF YOU HAVE ANY CLIENTS WHOSE POLICIES COULD POTENTIALLY BE CANDIDATES FOR A LIFE SETTLEMENT TRANSACTION, RIGHT NOW IS THE TIME TO ACT. SINCE THESE TRANSACTIONS DO NOT COME TO FRUITION OVERNIGHT, THE TIME HORIZON TO START THE BALL ROLLING IS VERY SHORT INDEED.

Please contact us for more information.

Any insurance agent who began there career with one of the big carriers was probably taught this method during their initial training. Don’t ask your friends, neighbors, dry cleaner, and anybody else who will listen if they know someone who needs insurance. Ask them who just got married or bought a house, who got promoted or started a new business, who has a new child on the way or stands to receive a big inheritance.

These are all examples of the triggers that Jantsch refers to in his article along with specific recommendations on how to use this concept in your business. I suggest you take a few minutes to read the rest yourself.

The final morning of the AALU meeting featured a “What’s Hot, What’s Not” presentation by two of the industry’s leading experts, Steve Leimberg and Larry Brody, who discussed three important subjects.  We will highlight these subjects in this and the next two posts.

Taxation of Life Settlements

Ever since the advent of life settlements, the tax consequences to the seller and to the purchaser have been the subject of conjecture, and while most agreed as to what those tax consequences were likely to be, there was never any authority for those conclusions.  We now have two IRS Revenue Rulings to guide us.

The first ruling, Rev. Rul. 2009-13, deals with the tax consequences to the seller (i.e., our client).  In most respects, it confirms what most had surmised would be the result, i.e., that gain over basis up to cash value would be taxed as ordinary income (the same as if the policy had been surrendered) and any gain above that amount would be taxed as capital gain.  The only surprise was the definition of “basis”, which, on a sale of the policy as distinguished from a surrender, is stated to be premiums paid minus the internal “cost of insurance” charges.  This adjustment to basis, however, serves only to increase the capital gain portion of the profit, not the ordinary income portion, which remains the same as if the policy had been surrendered.  While this basis adjustment increases somewhat the tax consequences of a life settlement, as long as the federal long-term capital gains tax rate remains at 15%, the additional tax will be relatively nominal.  Incidentally, the ruling also states that, if a term policy is sold, there is no basis other than unearned premium.

The second ruling, Rev. Rul. 2009-14, deals with the tax consequences to the buyer.  While this is not really of concern to us, here are the results in a nutshell:  (1) The buyer’s basis in the policy is the purchase price paid plus premiums subsequently paid.  (2) If the buyer re-sells the policy, the gain is capital gain.  (3) If the buyer collects the death proceeds, the gain is ordinary income.

Certainty in the tax law always stimulates interest in the underlying subject matter.  These rulings, therefore, can be expected to add even more life to the recovering life settlement marketplace.  Be sure to take advantage of this renewed interest. 

In light of the current economic environment, we have created "Simple Solutions for Difficult Times - 9 Tips to Boost Your Revenue with Provada". This online guide will provide you with ideas to help solve important client problems while creating sales opportunities for yourself.

We have included tips on a variety of subjects including annuities, defective trusts, IRAs, long term care insurance, life settlements, policy reviews, and more!

You can access the guide by going to our 9 Tips Website.  Make sure you click on the "Learn More" link after each tip for the detailed explanation along with other useful information.

Please let us know if you have any questions or need any assistance in implementing these or other ideas into your practice.

This confirms the view expressed in one of our prior blog posts from AALU that COLI-financed NQDC plans, and particularly SERPs, could well be today’s “perfect sale”.  And for those executives who wish to devote a portion of their current pay, or perhaps their bonus, to accumulating funds for their retirement but are reluctant to put those funds at risk by making a deferral of pay that then becomes subject to the employer’s creditors, life insurance owned by the executive individually could be the best answer.  If a given employer has enough executives, even institutional COLI products could be used here effectively.

The bottom line is that cash-rich life insurance, whether a COLI policy to finance a NQDC plan or individually owned, has become a widely accepted vehicle for accumulating funds for retirement on a tax-favored basis.  Now is the time to call on the businesses in your area, particularly those where you already have a connection.

In its simplest terms, it is a program established  by a grandparent who creates an ILIT for the benefit of grandchildren that will be the owner and beneficiary of a life insurance policy on the life of the middle generation (the grandchildren’s parent) that is funded under an endorsement method economic benefit non-equity private split dollar arrangement between the grandfather and the ILIT.  Under the new split dollar regulations, even though the ILIT is the nominal owner of the policy, the grandfather is the “deemed owner”, thus ostensibly justifying that it is indeed endorsement method split dollar.

The thrust of the arrangement is to claim a huge discount for the grandfather’s interest in the policy (which is equal to the greater of premiums paid by the grandfather or the policy’s cash value) as a result of severe restrictions placed on the grandfather’s interest and rights in the policy.

Will it work?  The discount is likely to be challenged by the IRS on audit, so a client who adopts this arrangement needs to be prepared for a fight.  However, if you have a client worth at least $25,000,000 who is willing to be aggressive, perhaps it’s something to discuss..

The five major risks associated with institutional premium finance that have adversely affected arrangements implemented over the last several years are:  Interest rate risk; Policy performance risk; Collateral risk; Investment risk; and Lender risk.  It does not take much imagination to figure out why recent adverse experience with each of these risks has led to a different premium finance marketplace today.

Institutional premium finance today tends to follow the following parameters:  (1) Shorter-term loans, in many cases no longer than 5 years.  (2) Higher basis point spreads over LIBOR, in the range of 250-350 bps, or perhaps even more.  (3) Letters of credit with fees as high as 300-400 bps.  (4) Stricter requirements on collateral, with real estate generally not being acceptable.  (5) Greater attention to product design.  (6) Longer-pay scenarios.  Within these parameters, however, institutional premium finance arrangements are once again becoming viable and available.

As stated in our prior comments, if you have a situation in which the client can pay the premiums but would prefer to use OPM for a limited period of time, be sure to contact us so that we can seek out the best premium finance arrangement to fit your client’s particular situation. 

Don’t let this happen.  Get Politically Active.  Have Political Impact.  Read how in our prior comments.