Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Use Life Insurance for Estate Planning
Transcript
- Lucas: So, Luna, we've spent 149 episodes picking apart trusts, private foundations, even art lending. But today, for our 150th, I want to talk about something that sounds almost too boring to be a wealth strategy: life insurance. Luna: Boring? Maybe. But I've heard that for ultra-wealthy families, life insurance can be the quiet engine of their whole estate plan. How does that work? Lucas: It's all about the estate tax. If you've got a $50 million estate, the federal estate tax can take up to 40 percent of the amount over the exemption. For 2026, that exemption is around $13.6 million per person. So a $50 million estate could owe something like $14.5 million in taxes at death. That's a massive check your heirs have to write to the IRS. Luna: Ouch. So life insurance is a way to cover that bill? I've heard of ILITs — irrevocable life insurance trusts. Can you break that down? Lucas: Absolutely. An ILIT is a trust that owns a life insurance policy on your life. You're not the owner — the trust is. Because the trust is irrevocable, the death benefit is outside your estate. So when you die, the payout doesn't count toward the 40 percent estate tax. It goes to your heirs, tax-free, in the trust. Luna: But if you don't own the policy, how do you pay the premiums? You can't just gift money to the trust without hitting the gift tax. Lucas: Right, that's where the Crummey power comes in. Named after a court case, it's a clause that gives the beneficiaries a limited window — usually 30 days — to withdraw any contribution you make to the trust. That technically makes the contribution a present-interest gift, which qualifies for the annual gift tax exclusion. In 2026, that's $19,000 per person, per beneficiary. So if you have three beneficiaries, you can gift $57,000 a year into the trust without any gift tax. Luna: So the beneficiaries have to be notified and given the chance to withdraw, but they usually don't? In practice, they just let it sit? Lucas: Exactly. They sign a waiver, the money stays in the trust, and the premiums get paid. It's a well-established legal dance. But the real magic is when you pair an ILIT with a second-to-die policy. Luna: Second-to-die — that's the one that pays out after both spouses pass, right? Lucas: Yep. It's often cheaper than two individual policies because it's based on two life expectancies. And it makes sense for estate planning because the estate tax hits at the second death. You get one payout that covers the tax bill when it's due. For a married couple with a large estate, that's a perfect fit. Luna: So who typically uses this? Is it just for the ultra-wealthy, or can a family with, say, $20 million in assets benefit? Lucas: Anyone who expects to owe estate tax. And remember, with a $13.6 million exemption per person, a married couple can shield $27.2 million. So if you're above that, a second-to-die policy in an ILIT can be a smart move. Let's say a couple has $40 million. They'd owe tax on roughly $12.8 million. A $5 million death benefit from a second-to-die policy could cover that, and the premiums might be just $50,000 a year, depending on their ages and health. Luna: That's a great return. But what about the premiums? For some families, paying $50,000 a year is nothing. But for others, that's a lot of cash flow. I've heard of premium financing. Can you explain that? Lucas: Premium financing is when a bank lends you the money to pay the premiums, typically for a large policy. The policy itself serves as collateral. Why do that? Because you'd rather keep your cash invested in the market than tie it up in premiums. The loan interest might be 4 to 5 percent, but if your portfolio is earning 8 percent, you're making a spread. Plus, the death benefit goes to your heirs tax-free, and the loan gets repaid out of the estate. Luna: So it's basically leverage on life insurance. But there's risk, right? What if the market drops or interest rates spike? Lucas: Exactly. If the loan is structured as a variable rate, a rising rate environment could eat into your returns. And if the policy underperforms — maybe the insurance company's dividends aren't as high as projected — you might have to put in more collateral. That's why it's not for everyone. But for the right family, it's a way to keep your investment portfolio intact while still getting the estate tax coverage. Luna: Let's talk about a specific case. A few years ago, I read about a family office that used a combination of an ILIT and premium financing for a $20 million policy. The wife was the insured, and they used a loan to pay the $200,000 annual premium. The family kept their $10 million bond portfolio untouched. When the wife passed, the death benefit paid off the loan and left $14 million for the heirs, completely outside the estate. That's a real example, minus the names. Lucas: That's a textbook illustration. And that's the kind of move that separates family offices from typical retail investors. They're not just buying insurance; they're engineering a solution. Luna: It's fascinating how these strategies are tailored. And you know, the fact that we can talk about this in depth, without any ads, is something I appreciate. We're not pushing a product or a sponsor. It's just the information. Lucas: Absolutely. We keep this show ad-free on purpose. If you find these conversations valuable, and you want to support that choice, you can find us at buy me a coffee dot com slash fexingo. It's a simple way to keep the lights on, and it lets us keep digging into the nitty-gritty of wealth management. Luna: Yeah, every bit helps. And it means we can keep episodes like this one coming. Lucas: So, back to the strategies. Another angle is using life insurance for key-person coverage in a family business. If a founder dies, the business might take a hit. A policy owned by the company or an ILIT can provide liquidity to buy out the founder's shares or fund a succession plan. That's a different kind of estate planning — it's about business continuity. Luna: That's a good point. And there's also the charitable angle. What about using a life insurance policy to fund a charitable remainder trust? Lucas: Sure. You can name a charitable remainder trust as the beneficiary of a policy. The proceeds go into the trust, provide income to your heirs for a term, and then the remainder goes to charity. That can reduce your estate tax and generate a charitable deduction. It's a way to combine two powerful tools we've discussed in past episodes. Luna: And what about the new rules around premium financing? I've heard that the IRS is cracking down on some abusive structures. What should our listeners be aware of? Lucas: The IRS has been focusing on 'stale' policies and improper valuations. But the core strategy is solid. The key is to work with experienced advisors who structure the loan properly, with a real lender, real interest, and a genuine intent to repay. If you're just doing it on paper, that's a red flag. But done right, it's a legitimate planning technique. Luna: So, for someone listening who thinks, 'Maybe this is for me,' what's the first step? Should they just call their insurance agent? Lucas: No, you need a team. An estate attorney who focuses on high-net-worth planning, an insurance specialist who understands large policies, and a tax advisor. They'll run the numbers, look at your estate tax exposure, and decide if an ILIT with second-to-die coverage or premium financing makes sense. It's not a DIY project. Luna: And what's the typical cost of setting up an ILIT? I'm guessing it's not cheap. Lucas: It can be a few thousand dollars in legal fees, plus the annual administration costs. But when you're saving millions in estate taxes, that's a rounding error. And remember, the trust needs a trustee — often a bank or family office — who will manage the policy and the Crummey notices. That's an ongoing cost, but it's usually a small fraction of the benefit. Luna: Let's touch on the psychological side. For many wealthy families, the idea of giving up control is hard. An ILIT is irrevocable — you can't change it. How do advisors help clients get over that hurdle? Lucas: It's a mindset shift. You're not giving up control; you're giving up ownership to protect your family. The trust document specifies who benefits and how. You can even have the trustee be someone you trust, like a friend or a family office. But the irrevocability is what makes it work for estate tax purposes. If you could change it, the IRS would say it's still your asset. Luna: That makes sense. And it's also about timing. When's the best time to set up an ILIT? Is it something you do in your 50s, or can it be later? Lucas: Earlier is better. Premiums are lower when you're younger and healthier. And the longer the policy is in force, the more the cash value can grow. But even in your 60s, it can still be worthwhile, especially if you have a large taxable estate. It's never too late as long as you're insurable. Luna: And what about the portability of the estate tax exemption? Is that a factor? Lucas: Portability is a useful tool, but it's not a replacement for an ILIT. If you rely on portability, you're just using the deceased spouse's exemption. But that exemption is subject to change and might not be available if the surviving spouse remarries. An ILIT locks in the tax benefit regardless of future law changes. That's valuable in a world where the exemption could drop in 2026, which is exactly what's happening. Luna: Right, because the exemption is set to revert to a lower level after 2025. Actually, it's already 2026, so we're in that new reality. How has that changed the conversation for families? Lucas: It's made life insurance trusts even more urgent. With the exemption at $13.6 million per person, a married couple can still shield $27.2 million. But for those above that, the tax bill is real. We're seeing more families in their 60s and 70s reaching out to set up ILITs because they know the window is closing. The clock is ticking, so to speak. Luna: Let's talk about a potential pitfall: the three-year rule. If you transfer a policy into an ILIT, the death benefit is only excluded from your estate if you live three years after the transfer. Is that correct? Lucas: That's right. If you die within three years, the policy is pulled back into your estate. That's why it's better to have the ILIT buy the policy from the start. If the trust purchases a new policy on your life, the three-year rule doesn't apply. So that's another reason to work with an advisor who knows the ins and outs. Luna: And for those who are worried about the cost of premiums, there's always the option of a paid-up policy. Some families purchase a single premium policy or a limited pay policy. That way, you fund it once or over a few years, and then it's done. Lucas: Exactly. That's another strategy. If you have a windfall, you could make a one-time gift to the trust, and the trust buys a policy that's paid up. You use a chunk of your lifetime gift tax exemption for that, but it might be worth it to avoid ongoing premiums. It's all about the trade-offs. Luna: So, bottom line: life insurance is not just for the middle class. For high-net-worth families, it's a sophisticated tool that can save millions in taxes and ensure wealth transfers smoothly. It's definitely something our listeners should discuss with their advisors. Lucas: And that's why we wanted to highlight it for our 150th episode. It's a cornerstone that often gets overlooked. Thanks for joining us, and here's to the next 150.