Quatloos! > Investment
Fraud > Financial
Planning > Life
Insurance to Pay Estate Taxes
This warning goes to the use of Life Insurance products
to generate moneys to pay estate taxes. We'll discuss this dubious
technique in a minute. First, a couple of caveats:
This warning does not criticize
the use of life insurance products by those who need them
to generate a pool of funds in the event of death to provide
essentials for loved ones.
This warning does not criticize
the use of life insurance which is purchased by an Irrevocable
Life Insurance Trust, so that the policy proceeds stay out
of the insured's estate.
This page does criticize the use of life insurance
for persons with an estate tax problem, to essentially provide
money to pay off the estate taxes.
Here, essentially, is the deal: You have a huge
estate which, when you die, is itself going to get killed by the
55% federal estate taxes. So, what you do is you go out and buy
a huge insurance policy. The insurance policy gets to grow tax
free, so that when you die there is enough in the policy to pay
the estate taxes. For example:
Therefore, to fight this:
You spend $5 million on life insurance. The
life insurance grows tax-free from $5 million to $20 million.
Now your estate is worth $35 million (your $20 million estate,
less the $5 million premium, plus the $20 million payout).
You now pay $19 million in estate taxes, which means that
your kids net $16 million -- a full $7 million ahead of where
you would have been if you hadn't bought any life insurance
at all! And this is paid for by the government, since they
have let your money grow tax free within the life insurance
Well, that's the theory anyhow. Everybody ready
for a healthy dose of reality?
The reality is that you have just paid Uncle Sam
$19 million in estate taxes, whereas before you were only paying
$11 million in estate taxes. Now, granted you are net ahead, but
only assuming that there was no way to let your money grow tax-free
and then to avoid estate taxes. In other words, you should
be growing your money tax-free, and then looking for ways to get
it to your kids without triggering estate taxes. And, the truth
is that there are some legal and fully-discloseable methods of
doing this using a combination of recognized methods in conjunction
with captive insurance companies. [Please note that you cannot
avoid all taxes using these alternative methods or any other method
-- pigs get fat and hogs get slaughtered -- but you can come out
well ahead of this goofy life insurance strategy.]
More reality which you have to face is that insurance
companies charge outrageous fees for life insurance policies and
pay huge commissions to the salesmen which pitch these things.
Somebody is paying for this, and it's you. If you are going to
be paying steep life insurance fees, you might as well be paying
them to your own captive insurance company instead of paying them
to someone else.
Don't be content to simply receive a disclose
that your advisor will receive commissions -- make your advisor
give you a definitive statement of the total remuneration to be
received by the advisor, both this year and in subsequent "tails"
from the insurance company. You WILL be amazed. And if you have
already bought a policy, make your advisor give you an accounting
of total commissions and tails received to date.
Private Placement Life Insurance
If you were going to purchase life insurance for
estate tax planning purposes, you would want to arrange what is
known as "Private Placement Life Insurance" (PPLI).
Very simply, PPLI is insurance which you or your advisor directly
negotiate with the insurance company, which should get you much
lower fees than if you went through an insurance agent (if for
no other reason than that the agent's commission are cut out,
letting more money "work" inside your policy -- i.e.,
it becomes true "no load" insurance). Also, the insurance
company and its actuaries will assist in structuring the PPLI
so that you get more bang for your bucks.
The differences between PPLI and ordinary life insurance
is huge, considering that MOST of your premiums often go to pay
commissions. Simply, if your estate will be large enough that
you will have estate taxes, you are better off getting one of
the better "fee only" insurance advisors to help you
set up PPLI. PPLI-VUL.com
is who we recommend.
The upshot of all this is that if you have enough
money to worry about estate taxes, you shouldn't be buying life
insurance. This is a bad strategy, and you are not only making
Uncle Sam and your salesman very happy, but you are also foregoing
other legal opportunities which will enrich your kids first and
everybody else second.
Backing Out -- Unsuitable Investment
We have seen so many people scammed into purchasing
excess life insurance as an estate planning strategy that some
of the litigation attorneys we know and refer work to are regularly
suing both the salesman and the insurance company to back them
out of the transaction, as well as for damages (including
punitive damages) for lost sales loads, fees and expenses, tax
penalties for backing out of the transaction, etc. For putting
clients into an unsuitable investment such as excess life insurance,
there are several good theories under which the salesman and insurance
company can be pursued, including:
Usually, all the jury needs to see is a statement
of the salesman's total commission to know that the transaction
wasn't made in the client's best interests.
From the 1 February 1999 edition of The Adkisson Analysis: "Charitable
Split-Dollar Life Insurance Plans Under Attack"
The Wall Street
Journal ran an interest article on January 22, 1999, entitled
"Charitable Legacy Insurance, Critics Say, Really Helps Donors"
which describes the so-called Charitable Split-Dollar Life Insurance
Essentially, the client makes a "gift" to a public
charity, and takes a full deduction of his or her taxes. The charity
then uses the money to fund a life insurance policy on the client
for the benefit of his heirs (and to a much less extent, the charity).
In theory, this allows the client to pass a bunch of money to
his heirs -- outside of estate taxes, since insurance policies
aren't taxed AND with tax deductible dollars AND with tax deferral
since income and gains accumulations within insurance policies
are not taxed.
In theory, this is a great strategy. These plans were marketed
by a California company called InsMark under the moniker Charitable
Legacy Plan, and they were an instant hit with insurance agents.
Yet the fact that it is so good is its greatest failing, for
it has incurred the wrath of the IRS. And it very likely that
by the time anyone in the plan dies, the IRS will have terminated
this particular strategy, and those who have already made their
gifts to the IRS will be stuck with, well, having made a gift
to charity -- and their families will likely end up with either
nothing or serious back taxes, and wishing that the money would
have gone to the Society for the Treatment of Stress Ulcers.
From all indications, the IRS will start challenging even the
initial deduction as tax shelters, meaning that not only will
the deduction be disallowed, but the people who bought into them
will also suffer serious penalties and interest. According to
Marcus Owens, the Internal Revenue Service's chief of tax-exempt
organizations, the strategy "can be a scheme to create tax
deductions where none existed. We believe some of these plans
are abusive tax shelters."
But the IRS isn't the only problem. Although InsMark soon started
charging hundreds of dollars for kits, most charities were refusing
to accept the plan -- fearing that they might lose their tax-exempt
status. Charities also didn't like the fact that they weren't
getting money immediately. Thus, most of the major charities,
such as United Cerebral Palsy, have simply refused to accept the
Finally, the National Committee on Planned Giving issued a warning
that the charitable split-dollar scheme could both expose the
client to severe tax consequences as well as cause the charity
to lose its tax-exempt status. Other critics warned that the charities
were making false statements when they verified that the client
was not getting anything in return for the donation (required
for the deduction).
Then, the IRS started requesting information from the few charities
that would participate in the plan, including the National Heritage
Foundation, and is now scrutinizing each and every plan, as well
as reviewing the exempt status of the charities that accepted
the plan. Indeed, the new 1999 IRS training manual instructs agents
to watch out for the plan, and to consider applying harsh tax-shelter
penalties whenever it is found. A couple of weeks ago, the IRS
denied an application for a nonprofit organization that was to
have been funded exclusively by plan gifts.
The Upshot: For many years we have eschewed the use of charity
as a planning tool. If you're going to give money to charity,
just give it. There are some good strategies involving charitable
giving, but all too many of them are like this one -- a loophole
just waiting to be closed with your neck in it.