The Biggest Story in Trust Owned Life Insurance (TOLI) in 2016? Trustees Running Away From Their Portfolios-How Can They?

In blogs published throughout 2016, we highlighted the increased challenges for TOLI trustees attempting to manage life insurance policies prudently. Life insurance cost increases more than doubled the carrying costs of many policies, while there were increased fiduciary and regulatory burdens and a multimillion dollar verdict against a major financial institution over a life insurance policy. All this occurred in 2016 and underlined the difficulties and risks associated with managing this asset.

Many banks and trust companies have TOLI portfolios that are filled with “orphan” trusts, with clients that have no other wealth-management relationship with the bank. These portfolios, many obtained through acquisition, often contain much more risk than revenue, and as institutions await a new presidential administration that appears to favor an end to the federal estate tax, some are looking for an exit strategy.

In the past year, we have witnessed and assisted in a number of “bulk transfers” of TOLI portfolios from institutions wishing to exit the business to other firms still committed to servicing this asset. The exiting firm can offload all of the TOLI trusts in their portfolio or just a select group. Generally, in a bulk transfer the selected trusts are moved at once, with one trustee taking control over them from another at a specified date. Obviously, this is not a transaction that will fit with every firm’s business goals, but for those that can take advantage of the transaction, it can be a true win-win scenario.

On Tuesday, December 13, at 2 p.m. Eastern time, ITM TwentyFirst University will feature Leon Wessels, a 15-year veteran of the TOLI industry, who will discuss Knowing Why, When and How to Move ILIT Accounts Out of Your Portfolio. This will be our last session of 2016, and if you are contemplating any changes to your TOLI business in 2017, it will be one you will want to attend. To register, click on the following link: https://www.itm21st.com/Education

 

Recent Court Case Identifies An Obvious Tax Liability: One TOLI Trustees Sometimes Miss

A recent US Tax Court Memo identifies the financial risk in unwittingly or intentionally mismanaging a life insurance policy. In 1987, a policy owner purchased a single premium variable life policy (since this was pre Code Section 7702A, it was not considered a modified endowment contract) with a payment of $87,500. The policy contract permitted the owner to take loans from the policy, allowing any unpaid loans and interest that accrued to be added to the “policy debt.” Once the policy debt exceeded the cash value of the policy, the carrier could terminate the policy after giving the policy owner notice and the opportunity to pay down the policy debt to avoid termination.

For 10 years the policy owner took loans totaling $133,800 and allowed the debt to grow over the ensuing years, even after receiving updates on policy values spelling out the growing interest and policy debt. In October of 2011, the carrier notified the policy owner by letter that he would have to make a minimum payment of $26,061 to avoid termination, which would cause a taxable gain. The owner did not make the payment, and the carrier terminated the policy and issued a 1009-R to the policy owner.

The policy owner did not report the income on his joint tax return, though he and his wife did consult with tax advisors, including one that told them they were “going to owe a bunch of money.” Instead, they affixed a handwritten note to their return that explained that they did not know how to compute the tax and that the “IRS could not help when called.” They asked for a “corrected 1040 explanation + how much is owed.”

As you can imagine, this did not end well for them. According to the Tax Memo, the loans taken “resulted in a policy debt of $237,897.25,” “the termination of the policy in 2011 resulted in the extinguishment of” that debt, and “$150,397.25 (the amount by which the constructive distribution exceeded his investment in the life insurance contract) was includable in their gross income.”

This particular case seems straightforward enough. “Phantom income” will be always be attributed to a taxpayer who allows a life insurance policy to lapse when the debt on the policy exceeds the cost basis, yet, at ITM TwentyFirst, we have seen situations in which trustees have allowed this to occur. After bringing in a portfolio of policies, I once asked a trust advisor about one particular whole life policy with a very large loan and was told not to worry because “that policy has lapsed.” Luckily, with a minimal payment, it was reinstated. If not, it would have resulted in a taxable event of almost $200,000 for a trust that had no cash assets.

In another case, the liability was less transparent and off in the future.  A grantor with a portfolio of whole life policies had not been paying anything into the policies for years, allowing loans to pay the premiums. When we took over, we reached out to the agent who said he “had a plan,” essentially allowing the interest and loans to accrue on the policy. When we reviewed the policies, we realized that shortly the portfolio would be in jeopardy, and in short order, cash contributions would have to be made, or taxable lapses would occur. Even with the cash contributions, each year as the loans grew, the net death benefit on the policies would drop. This was not a good situation, and one that could have been avoided with a little educated foresight.

These two cases highlight two types of liabilities for trustees. The first is easy to see (but sometimes is missed); the second can only be seen with a thorough analysis (which is often not done). On Tuesday, September 27, ITM TwentyFirst University will be hosting a free webinar entitled, How Trustees Can Avoid Getting Sued. The session will include the thorough analysis we provided on the second case above as one of the “real life” case studies. The session will provide one hour of continuing education for both CFP and CTFA designations. To sign up, simply click this link: https://www.itm21st.com/Education.

 

ITM TwentyFirst Taking Part in Week Long Education Course on Unique and Hard to Value Assets

ITM TwentyFirst will be participating in a week long course focused on administering Hard to Value Assets, to be held at the University of Notre Dame this Summer. Kelly Anders, Trust Administrator and Michael Brohawn CFP, CLU, Managing Director, will head up a day-long session focused on Trust Owned Life Insurance (TOLI) trusts and policy management.

The course, sponsored by Cannon Financial Institute, the nation’s pre-eminent provider of education and performance improvement programs for financial institutions, will run from July 10-16, 2016.

Duane E. Lee, II, Executive Vice President at Cannon, will act as lead instructor.  While Ms. Anders and Mr. Brohawn will focus on TOLI trusts, other leading industry experts will provide insight into managing other assets, including, Real Estate, Minerals, Oil & Gas, Privately-Owned Businesses, Loans and Notes, Tangible Assets & Collectibles, and Private Equity, Hedge Funds, Etc.

The sessions will focus on practical approaches to asset management and include many real life case studies designed to provide the session participant with a genuine exposure to industry best practices.

According to Kurt Gearhart, CEO of ITM TwentyFirst, participation fits in well with ITM TwentyFirst goals. “We believe strongly in fostering education opportunity, both inside and outside of our company.  All of our team members take part in a rigorous education program.  And over the years we have reached out to the trust and financial community with the introduction of ITM TwentyFirst University, which provides free CFP, CTFA and FIRMA continuing education credits to industry members via periodic webinars.  Taking part in the Notre Dame Cannon Financial Institute session is the logical next step in helping to inform the industry.”

While the initial sign up has been greater than expected, there is still opportunity to participate.  For further information you can go to the Cannon Financial Institute website, http://www.cannonfinancial.com/courses/unique-and-hard-to-value-asset-management/678