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Estate Planning - Example 1

You make investments for the legacy of your heirs. One must be aware that for every $1 you leave your heirs above the $1.2 million dollar exemption (or whatever your exemption is) will be subject to taxes. Lets say that your investments have a total value if $20 million and you die. At the time of your death your heirs will receive approximately $10 million. So therefore at that moment the day you die your your estate has halved to $10 million because of the estate taxes. In many cases estate taxes on assets over $3 million would be subjected to taxes of up to 55%. But for convenience purposes we will use the number of 50%.

However here is a way that you can use the full existing power of  your current investments to borrow the cost of your insurance so that you can earn a return which is equal to the full 10 million which would otherwise be lost to taxes, this would cost approximately $50,0000.

The returns from insurance are based on solid pre-calculated  figures and are not dependent on how the economy, the stock market or real estate returns. In this way insurance is different from most investments because you know exactly how it will perform based on your assumptions at the time of purchase. Lets say that we have a couple in their 60s. In this case it might be possible to get a 10 to 1 return on a life insurance policy. This policy would be placed in trust. In other words it will therefore cost $1 million in order to replace the $10 million that will be lost to estate taxes. It is important also that this return will be available to the heirs on the day the insurance is bought if an unforseen tragedy should strike and it will not be subjected to a 50% reduction in tax as long as it is structured correctly.

In this case you would have an outlay of approximately 5% percent of the total estate it is also fairly logical to assume that a 5% reduction in their estate would probably not affect the lifestyles of the couple in question and would be well worth it if it were to earn a return that would be equal to taxes that would paid on the death of the individual in question. In addition the $1 million dollar cost would only cost $500,000 in real terms because as said before if the money is left in the estate it will be subjected to 50% taxes the day that the individual dies. But in another scenario you dont even have to spend 1 million which we will discuss shortly.

Lets say you have an estate worth approximately $20 million you and LIBOR rates are currently at 5.%. In this case on $1 you could borrow the cost to fund the insurance policy. In this way a cost of $50,000 per year returns the amount of $10,000,000.

Lets say for example that the individual in this plan lives to the age of 80. in this case the individual would end up paying $50,000 per ear for 20 years for a total cost of $1,000,000. A $1 million dollar outlay yielding $10 million would not be something you would want to pass up.

Did  did it really cost 1 million? The answer is no if you are fairly calculating the costs. The reason for this is. Firstly if you did not pay the $1,000,000 it would have remained in the estate  and would have been subject to estate taxes at the death of the individual of approximately 50% and be reduced to $500,000. So the actual result is that you have purchased a $10,000,000 payout for the cost of $500,000 a return of more than 20 to 1.

Also most importantly you have to remember one thing. You have no guarantee that you are going to live to 80 or even next week. It is possible that might only pay 2 years of interest to produce the return of a $10 million dollar payout. In this case you would have purchase a return of $10 million for $100,000 or even less if you calculate the costs if you had left the money in the estate. But lets say you do live to 80 are there any stocks or real estate that will increase from$1,000,000 to $10,000,000 in twenty years guaranteed? and don't forget investment that you do make that does produce that kind of return will be subject to capital gains taxes unless it is sheltered in an IRA or retirement account. If not it would probably have to increase to a value of twenty million to produce the same returns as a $10,000,000 dollar life insurance policy.

At this point you might be thinking that the the $50,000 did not actually produce the $10,000,000 return because there is still the $1,000,000 that has to be taken into consideration. The $50,0000 per year were just debt service on the $1,000,000 loan and it is true that when the individual dies he will have to pay back the $1,000,000 borrowed from the policy would would increase the cost of the strategy, but still this only increases the total cost to $2,000,000 producing a return of $10,000,000 still a very effective return. But also remember this. The $20,000,000 million dollar estate would be reduced by inheritance tax to $10,000,000. But the outstanding $1,000,000 loan is a liability against the estate reducing the value from $10,000,000 to $9,000,000. The estate taxes are now payable on $9,000,000 not $10,000,000 therefore the estate taxes are $4.5 million not the original $5,000,000. So in effect Uncle Sam has paid for half of your loan that you used to buy the insurance policy.

In any case if the loan interest had it not been paid out of the estate would have been subject to estate taxes of 50% so if the $2 million had been left in the estate and not used for the  life insurance it would have been subject to 50% taxes which would have reduced it to only $1,000,000 to be left to your heirs. So in conclusion the the loan principal of 1 million was not really one million it was $500,000 and the loan interest was not really $1,000,000 but was also $500,000,. For a total cost of $1,000,000. Also remember that any other investment would have to produce a return of  $20 million to yield the same returns as the $10,000,000 life insurance payout, because the other investment would be subject to capital gains taxes.

Of course at different stages and ages in life the figures would change but the key results would stay roughly the same because with insurance (1)The returns are available the first day you buy the policy if tragedy strikes. (2) The returns are predetermined. (3) Left within your estate the returns would become half their value as a result of estate taxes. (4) Any investment in a non sheltered IRA would have to yield double the returns in a non IRA due to be subject to estate taxes.







Disclaimer the information provided in this site is for educational purposes only. The author accepts no liability for mistakes or inaccurate information that may be found in this site. Do not make any financial decisions without the aid of a registered financial advisor.