By Michael G. Chatzky, Chatzky & Associates, San Diego, USA
The acquisition of a foreign variable life insurance policy by an irrevocable life insurance trust can often provide an excellent combination of benefits, including among others: financial diversification of risk, financial offshore investment opportunities, asset protection of the insurance policy during the lifetime of the insured, asset protection of the insurance proceeds after the death of the insured, the elimination of the federal estate tax on the insurance policy and the insurance proceeds, the income tax deferral of the income generated by the insurance policy, the elimination of income tax on the payment of the insurance proceeds to the insurance trust, and the elimination of probate on the insurance policy and the insurance proceeds!
A. OVERVIEW OF ASSET PROTECTION PLANNING.
In asset protection planning the primary objective is to protect one’s assets against possible future claims of adverse parties. The need to protect one’s wealth has become more acute as our society has become more litigious. An adverse judgment can evaporate an estate that has taken many years to accumulate. Individuals and businesses in high-risk fields (such as physicians, developers, attorneys, and accountants) often implement an asset protection program as a key part of their estate planning and business planning.
Although one should responsibly pay legitimate creditor claims, a very serious situation has arisen in which frivolous illegitimate claims are frequently asserted against affluent parties or parties who have a large amount of insurance coverage that might apply against such a claim. Although there is almost a limitless variety of situations in which asset protection should be strongly considered, some of the more frequently encountered situations in which a party might wish to consider an asset protection program include, among others:
1. Malpractice Claims. Protection of the assets against malpractice claims by a professional who does not wish to pay exorbitantly high errors and omissions insurance premiums. (Also, it should be noted that many professionals avoid purchasing a large errors and omissions insurance policy because such a policy can become a magnet that can attract litigation against the professional.)
2. Judgment Creditors. Protection of the assets against unknown future judgment creditors. (Note: Asset protection planning frequently involves protecting specific assets to insulate them from being acquired by a creditor, while leaving other assets unprotected for the creditor to acquire.)
3. Marital Dissolution. Protection of the assets in the event of a marital dissolution.
4. Business Risks. Protection of the assets from business risks.
5. Personal Spending Problems. When a personal spending problem exists, such as when the party is a compulsive gambler, drug addict, or excessive money spender, asset protection planning should be considered to protect the assets from oneself.
The most appropriate time to engage in asset protection planning is before one encounters creditor problems. After a creditor has filed a lawsuit against a party asset protection planning becomes much more difficult and is far more likely to be heavily scrutinized and questioned by the creditor and the court.
The asset protection legal advisor needs to consider the applicable fraudulent transfer prohibition statutes, the bankruptcy and insolvency statutes, and other pertinent legislation. A challenger of the plan will likely examine the plan to determine if there has been a violation of any of these statutes.
B. FOREIGN ANNUITY AND INSURANCE POLICIES.
Foreign annuity and insurance policies are often available to high net worth individuals in the United States and elsewhere. They typically appeal to parties interested in international investments that are unavailable to United States investors who wish to “wrap” these investments into an insurance policy to take advantage of the attractive features provided by such a policy.
Domestic insurance policies often lack access to foreign investments and require the use of the United States dollar as the payment medium. Many foreign mutual funds are unavailable for purchase by United States investors because of highly restrictive stock registration and reporting laws that make it economically inefficient for such companies to sell to United States parties. However, foreign insurance companies can generally purchase such investments and can provide the payment of withdrawals, loans, and death benefit proceeds in a variety of currencies, providing potential protection against currency devaluation. Thus, foreign insurance products can provide significant financial diversification to protect against risk of loss at both the investment level and the currency level.
Foreign insurance policies written on the life of an insured who is a United States resident or citizen are generally subject to the payment of a 1% excise tax on premiums paid. However, this excise tax does is not imposed on insurance premiums (or reinsurance premiums) paid to a Swiss insurance company except to the extent that the risks insured against are reinsured with a party that is not entitled to the benefits of either the income tax treaty between Switzerland and the United States or to the benefits of any other income tax treaty between the United States and another country that provides a similar exemption from this excise tax. Thus, the issuance of a life insurance policy by a qualifying Swiss insurance company on the life of a United States citizen or resident can be exempt from this excise tax unless the insurance risk is reinsured by a third party that does not qualify for treaty relief from the excise tax with respect to the insurance premiums paid.
Foreign law can enhance the asset protection provided to the owner of the insurance policy. Many foreign jurisdictions provide statutory protection for the policy and prohibit the names of policyholders from being revealed unless a serious crime investigation is involved. In addition, it is very costly for a United States domestic creditor to bring a claim in a foreign court.
We frequently recommend that the foreign insurance policy should be owned by an irrevocable life insurance trust, which typically is the beneficiary of the insurance policy. This provides estate planning advantages (by removing the policy and the insurance proceeds from the estate of the insured), while providing a secondary level of asset protection.
A trust is a legal arrangement in which one party (the trustee) holds title to the trust assets for the benefit of the beneficiaries. The party who contributes the assets to the trust is called the settlor.
Because the settlor of a properly designed irrevocable life insurance trust is irreversibly transferring assets to the trust, and is surrendering the ability to manage and control such assets thereafter, the asset protection features of such a trust against the creditors of the settlor are significantly more powerful than would be the case if the transfer were to a revocable trust. Thus, the finality of such a transfer needs to be weighed against the asset protection advantages.
The establishment of the irrevocable life insurance trust is generally subject to federal gift tax. To avoid this consequence the trust might contain a “Crummey” provision that enables trust beneficiaries to have the right to withdraw trust corpus for a brief specified time period. This technique requires very careful handling to comply with the taxation rules and restrictions and dollar limitations.
The primary purpose of an irrevocable life insurance trust is to acquire and hold a life insurance policy that is excluded from the taxable estate of the insured for federal estate tax purposes. If the trust and transaction are properly structured and operated both the insurance policy itself and the insurance proceeds are excluded from federal estate taxation.
Typically, a parent is the settlor of the irrevocable insurance trust, an independent third party (either institutional or non-institutional, as the client prefers or the circumstances dictate) is the trustee, and the parent’s children or other intended testamentary recipients are the beneficiaries of the insurance trust.
The irrevocable insurance trust is generally an excellent asset protection tool. The trust typically contains a spendthrift anti-alienation provision that can protect the beneficiaries’ interests in the trust from creditors of the beneficiaries. Because the trust is irrevocable, it is unlikely that a creditor of the settlor can reach the assets in the trust if the trust is funded in a manner that does not violate any fraudulent transfer or fraudulent conveyance statutes or rules. (If such rules were violated, the attacking creditor might be able to set aside the transfer to the trust and/or obtain monetary damages for the transfer.)
Thus, the use of a foreign insurance policy that is fully compliant for United States tax purposes, and is issued by a foreign insurance company that is financially strong and fully compliant under the laws governing the company and the insurance policy can be an excellent tool in the wealth protection toolkit. These advantages can often be further enhanced if the insurance policy is owned by an irrevocable life insurance trust!