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Guest GTigers

Life Insurance Purchase from Qualified Plan by ILIT

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Guest GTigers

A salesman is trying to sell a friend of mine this idea.

That he can roll his IRA into a Profit Sharing Plan (this will need to be set up), then use the funds in the PSP to purchase life insurance (1 premium payment), and then an Irrevocable Trust can purchase the life insurance from the PSP (at its FMV). Thus, very little is left in the retirement plan to be subject to estate taxes and income taxes, and the life insurance pays out to the ILIT and avoids estate taxes.

To me it seems like a blatant tax shelter that the IRS would be all over, but just wanted to see if anyone had heard of this strategy. The strategy around it is fairly legitimate from what i can tell as they quote revenue rulings to value the life insurance, etc.

Any input is appreciated.

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Is the ILIT a subtrust of the plan (i.e. within the plan) or is it separate? If separate, the insured would first have to buy the policy from the plan, then give it to the trust.

A couple of things to consider:

-generally, life insurance premiums can't exceed 50% of cumulative contributions for whole life (25% for term and universal). I'm honestly not sure if rollovers count as contributions for this purpose. The theory I've seen is that rollover money could be withdrawn, therefore all of it should be available to buy life insurance...my question in response to that is "if you're using the provision that says you can withdraw it, then aren't you withdrawing it...and don't you have to pay tax on it?"

-determining fmv is a key factor, if you get past other hurdles. It's not $0, or whatever the (low) cash surrender value is!!! (Actually, with a single premium policv, it shouldn't be that low anyway.) It's pretty close to the single premium. So it doesn't make any sense whatsoever to a) rollover $x from IRA to plan, b) buy a policy for $x in the plan, c) take other money and buy the policy from the plan for $x. If he already has $x outside the IRA, just buy the da*n policy with that money!

Sounds like the agent has just enough knowledge to be dangerous.

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-generally, life insurance premiums can't exceed 50% of cumulative contributions for whole life (25% for term and universal). I'm honestly not sure if rollovers count as contributions for this purpose. The theory I've seen is that rollover money could be withdrawn, therefore all of it should be available to buy life insurance...my question in response to that is "if you're using the provision that says you can withdraw it, then aren't you withdrawing it...and don't you have to pay tax on it?"

I addressed this issue a long time ago. I got a general information letter from Jim Holland, dated May 7, 1993 that specifically says "Because rollover money is neither a "contribution" nor a "forfeiture", no portion of the rollover money is taken into consideration when determining the amount of premiums that may be used to provide an incidental level of insurance coverage."

The question I sent was specifically in relation to using "seasoned" money to purchase life insurance.

It's not a Rev. Rul., but I'm pretty comfortable with it.

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Thanks Bill. I know you've posted it before...you will probably have to remind me again in 5 years, when it comes up again. But I kinda sorta had a feeling that was the case.

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Thanks Bill. I know you've posted it before...you will probably have to remind me again in 5 years, when it comes up again. But I kinda sorta had a feeling that was the case.

I wasn't trying to call you out. I just meant that it was something I had dealt with a long time ago.

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Guest GTigers

The ilit was not a subtrust of the plan, so yes, the policy was being sold to the ilit directly (individual first gifting money to the ilit to be able to buy the policy).

THe agent is quoting the fmv to be 10% of the original premium if sold in 3 years. So a substantial reduction in taxes deferred in the plan and LI will avoid estate tax.

Basically, if the psp is being set up just to do this transfer there is no business purpose. I would still assume the IRS would call this a sham transaction. Still appreciate any thoughts on this and thanks for the replies.

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THe agent is quoting the fmv to be 10% of the original premium if sold in 3 years. So a substantial reduction in taxes deferred in the plan and LI will avoid estate tax.

TEN PERCENT of the premium? How can this possibly comply with the FMV guidance in Rev Proc 2005-25? Ask the insurance company for a calculation of the FMV pursuant to the Rev Proc. As I recall the MOST a policy value can be reduced for surrender charges is 30%, and maybe not even that, as there are some calcs that must be done. Even if it got the max reduction that would still leave the policy at 70%, maybe less a bit for mortality and expense charges.

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TEN PERCENT of the premium? How can this possibly comply with the FMV guidance in Rev Proc 2005-25? Ask the insurance company for a calculation of the FMV pursuant to the Rev Proc.

Amen. Google "springing cash value" while you're at it.

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Insurance agents are desperate to find money to pay insurance premiums with. Unfortunately for them, IRA funds may not be used to purchase life insurance. So they come up with desperate strategies such as this one. Besides I would never recommend that someone establish a qualified plan simply to provide a rollover mechanism to be able to purchase life insurance.

In IRS's view, the fair value to sell the contract at is the greater of the sum of the premiums paid or the surrender value. The strategy will not work.

From an estate planning point of view, by doing things this way, the policy, once in the ILIT, will still be in the estate for the next couple of year as a "transfer in contemplation of death". A new policy issued to the ILIT, even if funded by an IRA distribution, would not be.

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I'd also think the client, and the client's tax counsel, should take note of the "recurring and substantial" contribution requirement for a profit sharing plan, found in 1.401-1(b)(2). This whole arrangement seems improper to me.

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Guest GTigers
TEN PERCENT of the premium? How can this possibly comply with the FMV guidance in Rev Proc 2005-25? Ask the insurance company for a calculation of the FMV pursuant to the Rev Proc.

Amen. Google "springing cash value" while you're at it.

Thanks for all of the responses. I definitely didn't feel like the structure would be legitimate but wanted more substantial information to back up my assumption.

Springing Cash Value was very helpful.

The agent still lists revenue rulings 2005-25 to back this structure and the sale from the PSP to ilit for the PERC value, and saying that the PERC value of the policy at the end of year three is 10% of the original one time premium (he has the PERC from the insurance company). Basically, after the fact that the PSP is not being established for a business purposes, I still do not trust his sales value.

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The agent still lists revenue rulings 2005-25 to back this structure and the sale from the PSP to ilit for the PERC value, and saying that the PERC value of the policy at the end of year three is 10% of the original one time premium (he has the PERC from the insurance company). Basically, after the fact that the PSP is not being established for a business purposes, I still do not trust his sales value.

Doesn't add up if you read the Rev Proc (not ruling). PERC is premium, earnings and REASONABLE charges for mortality and expense. Then you hit it with the surrender factor, which is probably 70% based on the quote below. for the policy to be worth 10 cents on the dollar in year 3 the supposedly reasonable mortality and expense charges would have to have consumed all earnings and 85% of the principal. If this is true, the charges are certainly not reasonable.

From Rev Proc 2005-25:

(2) Qualified plans. In the case of a distribution or sale from a qualified plan, if the contract provides for explicit surrender charges, the Average Surrender Factor is the unweighted average of the applicable surrender factors over the 10 years beginning with the policy year of the distribution or sale. For this purpose, the applicable surrender factor for a policy year is equal to the greater of 0.70 and a fraction, the numerator of which is the projected amount of cash that would be available if the policy were surrendered on the first day of the policy year (or, in the case of the policy year of the distribution or sale, the amount of cash that was actually available on the first day of that policy year) and the denominator of which is the projected (or actual) PERC amount as of that same date. The applicable surrender factor for a year in which there is no surrender charge is 1.00. A surrender charge is permitted to be taken into account under section 3.04 of this revenue procedure only if it is contractually specified at issuance and expressed in the form of nonincreasing percentages or amounts.

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Guest VEBAPLAN

VebaGuru is correct Agents cant use the plans below, so now they are up to new scams, like section 79 and probably the plan described.

PRODUCERSWEB.com

For Smart Advisors

Get Sued

By Lance Wallach Wednesday, April 8, 2009

The IRS is cracking down on what it considers to be abusive tax shelters. Many of them are being marketed to small business owners by insurance professionals, financial planners and even accountants and attorneys. I speak at numerous conventions, for both business owners and accountants. And after I speak, I am always approached by many people who have questions about tax reduction plans that they have heard about. Below are the most common.

419 tax reduction insurance plans

These come in various versions, and most of them have or will get the participant audited and the salesman sued. They purportedly allow the business owner to make a large tax-deductible contribution, and some or all of the contribution pays for a life insurance product. The IRS has been disallowing most versions of these plans for years, yet they continue to be sold. After everyone gets into trouble and the insurance agents get sued, the promoters of the abusive versions sometimes change the name of their company and call the plan something else. The insurance companies whose policies are sold are legitimate companies. What usually is not legitimate is the way that most of the plans are operated. There can also be a $200,000 IRS fine facing the insurance agent who sold the plan if Form 8918 has not been properly filed. I've reviewed hundreds of these forms for agents and have yet to see one that was filled out correctly.

When the IRS audits a participant in one of these plans, the tax deductions are lost. There is also the interest and large penalties to consider. The business owner can also be facing a $200,000-a-year fine if he did not properly file Form 8886. Most of these forms have been filled out improperly. In my talks with the IRS, I was told that the IRS considers not filling out Form 8886 properly almost the same as not filing at all.

412(i) retirement plans

The IRS has been auditing participants in these types of retirement plans. While there is generally nothing wrong with many of the newer plans, the IRS considered most of the older abusive plans. Forms 8918 and 8886 are also required for abusive 412(i) plans.

I have been an expert witness in a lot of these 419 and 412(i) lawsuits and I have not lost one of them. If you sold one or more of these plans, get someone who really knows what they are doing to help you immediately. Many advisors will take your money and claim to be able to help you. Make sure they have experience helping agents that have sold these types of plans. Don't let them learn on the job, with your career and money at stake.

Do not wait for IRS to come and get you, or for your client to sue you. Time is of the essence. Most insurance professionals need help to correct their improperly completed Form 8918 or to fill it out properly in the first place. If you have not previously filled out the form it is late, and therefore you should immediately seek assistance. There are plenty of legitimate tax reduction insurance plans out there. Just make sure that you know the history of the people with whom you conduct business.

Remember, if something looks too good to be true, it usually is. Be careful.

Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. Contact him at 516.938.5007 or visit www.vebaplan.com.

The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

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Guest GTigers
The agent still lists revenue rulings 2005-25 to back this structure and the sale from the PSP to ilit for the PERC value, and saying that the PERC value of the policy at the end of year three is 10% of the original one time premium (he has the PERC from the insurance company). Basically, after the fact that the PSP is not being established for a business purposes, I still do not trust his sales value.

Doesn't add up if you read the Rev Proc (not ruling). PERC is premium, earnings and REASONABLE charges for mortality and expense. Then you hit it with the surrender factor, which is probably 70% based on the quote below. for the policy to be worth 10 cents on the dollar in year 3 the supposedly reasonable mortality and expense charges would have to have consumed all earnings and 85% of the principal. If this is true, the charges are certainly not reasonable.

May have something to do with how he has structured the insurance. The first two years have insurance of about $6 million and then the insurance drops to $1.5 million. It's a weird illustration, and my friend was presented an email from the insurance company verifying the low Perc value, which is what they are quoting as the sale price from the qualified plan to the ILIT.

I think this sentence in 2005-25 may help me explain why this doesn't work as well "If the insurance contract has not been inforce for some time, the value of the contract is best established through the sale of the particular insurance contract by the insurance company (iei. as the premiums paid for that contract)." It also says "at no time are these rules to be interpreted in a manner that allows the use of these formulas to understate the FMV of the life insurance contracts and associated distributes and transfers."

Even though I dont quite follow the math behind the sales value 2005-25 sets out, i'm pretty sure common sense point me that those two sentences are very relevant in this transaction.

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Guest VEBAPLAN

I was an expert witness in a Federal Court case on point. The Plaintiffs, my side won a lot of money. They went into a similar scam. Lance Wallach

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