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Quatloos! > Investment Fraud > Financial Planning > Life Insurance to Pay Estate Taxes

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.

The Theory

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:

  • You have a $20 million estate. When you die, this estate will pay $11 million in estate taxes, leaving your kids with a net of $9 million.

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 policy!

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. 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 Litigation

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:

  • Securities Fraud and Insurance Fraud

  • Breach of Fiduciary Duty and Professional Negligence by the Advisor

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.

Update: 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 Plan.

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 plan.

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.

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