Taxes are in play again. And then they’re not. Income tax, wealth transfer tax and the income tax aspects of wealth transfer planning were all in play, with near-term effective dates that had estate planners and life insurance professionals scrambling to get things done before an uncertain deadline. However, as I write this article, the proposals ended up on the cutting room floor, as a very different vision for taxation of the wealthy emerged from Congress.
Forewarned is Forewarned
It hasn’t been lost on estate planners and life insurance professionals that those far-reaching proposals, particularly the ones that so negatively impacted irrevocable life insurance trusts (ILITs) could be reinserted in the Congressional script at any time. They were a shot across the bow that told estate planners, life insurance professionals and, of course, their clients that it would be wise to press ahead with the planning while the pressing is good, not to mention the underwriting. That’s why I expect to see a continuing effort to market life insurance to ultra-high-net-worth (UHNW) individuals for estate liquidity and “pure” wealth transfer.
Assuming I’m right, estate planners who work with these clients are likely to be asked to review more presentations of plans to finance policies in what will be described as “sophisticated tax and economically efficient” structures. Loosely translated, the word “review” means “figuring out if it works.” Having sat through more than a few of those presentations, I would like to offer some suggestions for adjusting the dial in a presentation to a frequency that considers the respective interests of the client, the advisors who’ll have to tell the client whether the proposed structure “works’’ and, of course, the insurance professionals who make the presentation. The ability to adjust that dial for the clearest reception is especially critical today, with so much of the planning landscape potentially in flux.
A Path to Uncommon Success
Your phone rings. It’s a relatively new estate-planning client, a woman who recently sold her successful business and now considers herself to be an investor. The sale resolved the estate tax liquidity crunch that she had dealt with for so many years. It also increased her wealth substantially! While estate tax liquidity per se would no longer be a problem, she still has a keen interest in exploring ways to maximize the amount of her estate that would pass to her family net of estate tax. You’ve explained to her that certain proposals that would have made it much more difficult to preserve her estate from taxes are apparently no longer in the offing. But if recent past is prologue, it makes sense to take what the tax law gives you while it does. She agrees. One of the things you suggested to the client is that she include life insurance planning as part of that exploration. As it happens, that was the subject of an interesting conversation she just had with her life insurance agent, Bill Ledgerman. Bill, in turn, said that he would like to introduce her to a group from out of town that specializes in sophisticated life insurance planning for UHNW individuals.
Your client tells you that Bill gave her a high level overview of the array of plans or programs that he and the group can customize to her circumstances and objectives. The plans would likely take into consideration her existing insurance as well as new coverage to deal with her now substantially larger estate. Reading from her notes, she says that the plans cover the gamut. She heard references to various types of life insurance trusts, exemptions and sunsets, generation-skipping, split-dollar regimes, collateral this or that, loans, interest rates, investment returns, wealth transfer, highly rated companies, institutional (or was it constitutional?) pricing and more. She also says that Bill underscored your own admonition about how some of the proposals could have significantly diminished her ability to take utmost advantage of these kinds of plans. She now wishes that she had a glossary before the call! Anyway, the client goes on to say that she told Bill that she’s interested, but he would have to run all this past you and her tax advisors. In fact, you should be hearing from Bill about scheduling a call. You say, “That’s fine. I’ll put on my helmet, listen, ask some questions, review their material, consult with your tax people and let you know what I think.”
Setting the Ground Rules
Shortly after you’ve spoken with the client, you hear from Bill. As it happens, you know Bill from your involvement in the estate-planning community. But you’ve never had an opportunity to work with him on a case. Bill asks for some good dates for a call. They have a slide presentation that usually takes about an hour to go through. “Does that sound okay?” Bill asks you. You tell Bill that, before you set a date for the call, you would like to set some ground rules for the presentation. You also tell Bill that the client’s tax advisors will be on the call.
Bill is a pro who really knows his business. What’s more, he understands your mission and your responsibility to the client. He understands the risk you take on if you tell the client that the plan works and the extent of the due diligence you’ll have to do to mitigate that risk. He knows that if, during the course of the presentation, you begin to wonder how you’ll ever give the client a fair assessment of the plan or how you’ll ever manage your own risks if something goes wrong, you’ll tune out and just tell the client that, well, you know. He also shares your concern that the window of opportunity to do optimum planning may be closing fast. Bottom line, he knows that the shortest distance between the first call and eventually getting down to business with the client, you and the tax advisors, is to make that call as substantive and productive as possible. So he suggests that there’s no time like the present to collaborate with you on the ground rules.
He starts by telling you about the other firm so that you and the tax advisors can do your research and save time on introductions on the call. You suggest, and Bill agrees, that you and the tax advisors should have the slides in hand before the presentation so you can take notes and, importantly, pose questions during the presentation that would otherwise have to wait for a second call.
Points for Discussion
You and Bill go on to agree that discussion of a given plan should include the following points for the reasons noted. Your approach reflects the fact that in light of the potentially tight time frame, the objective is to strike the right balance between illumination and inundation.
- Include key elements of the plan’s structure: a step-by-step, building block description of how and why the plan works, along with all key assumptions for both the plan and the policy that are used in the presentation. Pictures and diagrams are welcome!
- You should see detailed exhibits that depict the key benchmark values through the life of the plan or the client’s life expectancy, if longer.
- You should see the complete illustration for any policy whose premiums and values were incorporated in the exhibits. The illustration will enable Bill to tie the numbers shown in the slides back to the policy used in the presentation. The illustration will also tell you what kind of product is being used, how it’s designed and funded pursuant to the specs of the plan and which assumptions ought to be tweaked, as discussed below.
- In addition to a base case scenario, you would like to see exhibits and the supporting policy illustrations depicting a couple of “what if” scenarios that involve different assumptions and variables for the plan and the policy, respectively. You’re not suggesting that they walk you and the tax advisors through each scenario and illustration during the presentation. Bill can do that later. You and Bill wholeheartedly agree that there’s no need to destroy a virtual forest to get the points across. All you’ll need is enough of a “delta” between good and bad outcomes to enable the client to see how the variables can work for or against her. To save time and a lot of guesswork on Bill’s part, you identify a couple of “what if” scenarios you would like to see.
- You should see any sample plan documents, administrative agreements, etc.
- You would like to see references to the operative tax guidance for the plan:
- You learned long ago that when a plan involves an ILIT, you have to understand the income, gift, estate and generation-skipping transfer tax implications of the plan throughout its life cycle, that is, when it’s structured and implemented, when and if it needs to be “fixed” and when it comes to an end, one way or another. Having that understanding has allowed you to collaborate with a client’s tax advisors to craft transactions with a set of tax shock absorbers, just in case. That was a rigorous enough exercise when the tax laws were relatively static, emphasis on “relatively.”
- Now however, with income and transfer taxes, including the traditional treatment of irrevocable grantor trusts in play under some proposals, key aspects of the current operative guidance for a plan could be obsolete in a big time way a year from now, if not sooner. And then what? You won’t take the presenters’ time on this during the call, but the “what ifs” on the operative guidance for the plan will call for careful study and, perhaps, tomorrow’s newspaper.
- Figuring out if the plan works is a piece of cake compared to figuring out what to do if it doesn’t! Therefore, with the above as prelude, and having set forth the economic, tax and product performance risks associated with the plan, you would like the presenters to describe the protocols and strategies for managing those risks. It’s also about your own risk management and how unhappy the client would be with you if you hadn’t included a check of exit strategies from the plan as part of your review! So, experience has taught you to focus on the “what ifs” that could cause a client to want to get out of a sophisticated, tax-oriented life insurance strategy without losing the coverage or their shirt. You’re talking about exit strategies, namely those that don’t involve the client/insured’s death. You’re talking about what can be done if the split-dollar loan, for example, starts to outperform the policy that it’s financing. Or maybe those term costs are aging less gracefully than the client. Or maybe you’re talking about the client experiencing cash flow problems that make it difficult to support the plan. Or maybe you’re talking about another change in the tax laws that pulls the rug out from under the plan. But regardless of the cause of the pain, you need to get a handle on the economic and tax costs of the triage:
- Therefore, in addition to the base case and a couple of variations on that case, you again work with Bill to identify a set of variations on the theme of “I want out” that depict when, how and at what economic and tax cost the client can get out of the arrangement and what condition the policy will be in after the exit. Every exit strategy should be supported by an illustration. For example, if a split-dollar loan is going to be repaid by a withdrawal from the policy, show it. You want to see whether and when it would work and what shape the policy would be in after that.
- The implications of the proposed treatment of grantor irrevocable trusts on the design and operation of a tax-efficient plan are one thing. The implications on exit strategies create an entirely different but equally important set of considerations. Grantor trust status and the associated planning have long been a tailwind for many tax-efficient plans, enhancing their chances for operational success or facilitating damage control if problems occurred. For example, currently anyway, a split-dollar arrangement that’s living a life of quiet desperation can often be rescued by a gift of appreciated income-producing property to the ILIT or maybe a grantor retained annuity trust or a sale to the grantor trust ILIT. The potential loss of the benefits of grantor trust status will make it more difficult to assess the efficacy and risk profile of a given plan.
- You wonder how to possibly capture all these contingencies in a summary for the client that will get the points across without leaving her head spinning. Then, Bill has an idea. “Let’s develop a kind of ‘crisp, intuitive, heuristic schematic’ that basically says, ‘Hey, if this happens, then here’s what you can do and how you can do it.’” Bill gets a star for creativity!
- Again, you won’t take the presenters’ time to get into this on the call. You, Bill and the tax advisors will cover it afterwards.
Post-Call
It’s been a good call! You thank each other for your input and cooperation. You ask Bill to confirm that the presenters will abide by the agreed terms and, if they will, to get the call on the calendar with the tax advisors.
Bill likes the way this is unfolding. He knows what you and the tax advisors will expect, so he knows exactly what he and the group should cover, emphasize and anticipate. He’ll save a tremendous amount of time, if not in the preparation, then by avoiding any time-consuming retracing of items not covered or adequately explained. Most of all, this kind of structure gives him the opportunity to show you and the tax advisors, and therefore the client, how he brings his considerable knowledge, experience and listening skills to bear in this high level type of case.
You also like the way this is unfolding. You’re satisfied that you’ve done a good job with the staging for the rest of the production. You’ve framed the discussion in a way that will enable the client to appreciate the value that a creative and collaborative team can add to her liquidity and wealth transfer planning. You’ve set the ground rules that will help you manage your risk. And, come to think about it, you have a couple of other clients you might want to talk about with Bill.