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Premium Deficiency Reserves-inconstancies In Practice

At a basic level a premium deficiency exists when unearned premium and expected future premium are not sufficient to cover future estimated losses, loss adjustment expenses, policy acquisition costs and maintenance costs. In other words, a premium deficiency reserve is required if you expect a net loss in future periods for the particular policy, line of business, segment or company that has already been written.
Divergence in practice have evolved regarding at what level one should apply their analysis and which method should be used to calculate any resulting reserve. Should one look to the policy level, and perform a review of multiple contracts or do one high level review? Once you determine you have a premium deficiency how should you calculate the premium deficiency reserve?

To answer these questions we first have to understand the theory and guidance relative to premium deficiency reserves. We will also look quickly at how practices have evolved over time in different segments of the insurance industry
Guidance on Premium Deficiency Reserves
Generally Accepted Accounting Principles (“GAAP”) and Statutory Accounting Principles (“SAP”) are fairly consistent in their definitions of premium deficiency reserves. The general premise is that a premium deficiency reserve is required when unearned premium at a specific balance sheet date would be insufficient to cover expected future losses and loss adjustment expenses. Under GAAP one also considers the amortization of deferred policy acquisition costs and maintenance costs. As acquisition costs are expensed as incurred under statutory guidance they are excluded from a statutory analysis of premium deficiency. In practice we recommend that companies begin analyzing for premium deficiency when loss ratios exceed 90%.
In theory traditional recognition of premium and losses under GAAP and statutory guidance rely on the concept of matching. Both GAAP and SAP defer future income and attempt to recognize the income during the same period as associated future losses. However, when future losses are expected to exceed premium such losses must be accrued for when determinable. This concept of accruing for losses when they are detainable creates the need for premium deficiency reserves.

Premium Deficiency Reserves in Practice
In order to understand premium deficiency reserves fully it helps to understand the industries in which they are more commonly found. Industries such as life insurance, mortgage guarantee insurance and warranty insurance are typically required to analyze for premium deficiency reserves. These industries normally collect premium monthly to cover losses incurred during the associated period. In such industries unearned premium is minimal due to the premium earning cycle. Additionally, losses are not recorded until actually reported, as claims not yet reported are considered to be associated with future premium payments received. In order to determine premium deficiency reserves in these industries actuaries have historically performed projections of expected future premium. The present value of expected future premium inflow was than measured against the present value of expected future claims and applicable costs to determine the need for premium deficiency reserves.

While more frequent in lines of business with long-term contractual commitments such as life, warranty and mortgage guarantee insurance we have seen an increase in premium deficiency questions and recognition due to the current soft market. We have also noted a divergence in practice in the area of premium deficiency measurement in companies with multiple lines of business and operating companies.

Premium Deficiency Measurement
Statutory and GAAP guidance both state that an insurance contract should be grouped in a manner consistent with how policies are marketed, serviced and measured. GAAP guidance adds that contracts should be grouped using the same method as a company uses to measure profitability of its insurance contracts. While these definitions appear to be clear and concise there has been much debate regarding the specific language for contract groupings.

Extremes in practice have gone from using the total amount from the NAIC Annual Statement (creating one group and one PDR projections) to policy groupings based on each policyholder (creating one projection per customer). The most common form of grouping we have encountered is found between these extremes, grouping applied by line of business or legal entity.

In practice we have found that GAAP entities generally consider grouping on a consolidated entity basis and statutory entities generally group on a legal entity basis. Therefore a company with twenty legal entities writing two lines of business may end up with twenty individual analysis under statutory guidance and two under GAAP.

The level of grouping matters because of different rules regarding offsets between groups versus within a group. As stated in SSAS 53, “Deficiencies shall not be offset by anticipated profits in other policy groupings.” A PDR can go no lower than zero for a particular group and therefore a negative indicated reserve for one group does not offset a positive indication in another group. However, unlimited offsetting is allowed within a group. Therefore, one group means unlimited offsetting and a lower PDR and multiple groups mean limited offsetting and a higher PDR.

We believe that groupings will continue to vary from company to company; however, we recommend that companies base their measurement decisions on the guidance provided and clearly document their reasoning for their application. One item to consider is that policies grouped together by large insurance carriers may be very different than the policy grouping for smaller insurance companies or captive insurance companies. This is easily illustrated by looking at the three consideration areas of marketing, servicing and measurement and contrasting them between a large nationwide home and auto carrier and comparing them to a small home and auto carrier in the North East.

A nationwide home and auto carrier may group all of New England together as one market circle if their pricing and marketing strategy is consistent by geographic area. They may also service policies based upon the same geographically determined market circles. Servicing of proof of loss, eligibility determinations, billing processing and claims processing may be organized geographically by regional headquarters.

However, a small home and auto carrier in the North East may elect to build a market niche by focusing on a specific risk such as farms, vacation homes or mobile homes. It would follow that they may organize departmentally into silos serving each market niche. Each company’s business model is different so their grouping for a PDR analysis should also be differ.

Calculating the Premium Deficiency
Once an analysis determines that there is a premium deficiency for a specific group of policies, one has to determine the value of the projected premium deficiency reserve. Doing so involves the actuarial determination of future claim costs, and premium inflows. There is no official guidance on what actuarial method should be used to calculate the anticipated investment income that may be included in the premium deficiency test. As a result, there are varying industry practices. The two primary methods used in practice are the expected investment income approach and the discounting approach. The expected investment income approach computes anticipated investment income on all of the cash flows generated by current in-force contracts. The discounting approach discounts expected future payments for claim costs, claim adjustment expenses and maintenance costs. Both methods incorporate the time value of money into the calculation of the premium deficiency reserve.

Final Thoughts
Statutory and GAAP guidance does not define a consistent method of measuring and calculating premium deficiency reserves. In fact, guidance allows flexibility and judgment in application of policy grouping and calculation methods utilized. Whichever approach taken, the company should clearly document their reasoning and justify the selection of groupings and calculation methodology based upon applicable statutory and GAAP guidance. To avoid the possibility of audit adjustments and post close fire drills we recommend that companies with loss ratios over 90% implement a well documented and consistently executed policy for determining a premium deficiency reserves. Doing so will greatly reduce inquires from your auditors and regulators.

Secrets For Buying Medigap Insurance – Some Questions To Pose

You need the truth about wellness insurance, not just what many random person has mentioned on the Web. There are scores of self proclaimed professionals out there, although you want to know the right details & be assured that it is legitimate. You’ll most likely find exactly what you’re trying to find in this feature.

Be aware that most cancers aren’t dealt with below a basic medical insurance plan – only the pre-screenings could be handled. There are other insurance plans out there that only cover cancer, yet they could not be right for you. Establish in case you have a further risk for cancer, high risk would incorporate: smoking, exposure to hazardous chemicals or waste, & age above 40.

In the event you have exceptionally superb wellness & don’t know of any medical issues that run within your family, then it is reasonably secure to decide on a minimum wellness insurance coverage. The price is linked to coverage. So, why pay for something you aren’t going to use?

Picking a comprehensive wellness insurance plan for you or your family can mean the distinction between life & death at several points. While you can go to the hospital, it can expense you plenty of revenue & put you in debt. Getting a health insurance plan will save you lots of trouble and revenue.

A excellent wellness insurance tip that can save you a lot of revenue is to ease up on getting pharmaceutical drugs prescribed to you by your physician. Pharmaceutical organizations are making a killing from selling pharmaceutical drugs and the rates will only get higher. Only use pharmaceutical drugs should you want to.

Taking a close look at the terms of your health insurance policy will save you a good deal of worry when you want to use your coverage. Understand the level of maximum coverage as well as any deductibles that could apply to the services you use. Don’t hesitate to ask questions if there is something you don’t grasp.

Young people often skip getting well being insurance because they feel they are too young to get seriously ill. But, there are causes to seek healthcare that don’t involve illnesses – injuries and accidents can take place to anybody at any age. There are plans primarily for younger individuals who can cover these varieties of situations, commonly with a further deductible & lower price than conventional well being insurance.

If you are a university student, check if your university offers a health insurance plan. University well being insurance plans can be a superb choice if a student is no longer listed as a “dependent” under their parents’ plan. Students who are nonetheless included as “dependent” under their parents need to check to be sure they aren’t automatically asked to pay for a school well being plan. Doing research into these plans can enable you save revenue on health insurance.

In summary, you want to be cautious who you take guidance from with regards to wellness insurance. It’s essential to you that you’ve the right data & that is is portrayed in a clear & concise manner. Hopefully the points provided in this post will be more than valuable for you.

Review And Key Features Of Aviva Ilife And Aegon Iterm

How would you decide that the life insurance policy you are going to buy is simply perfect for you? Nothing can be much more useful and even sensible way to deciding ideal insurance policy than doing life insurance comparison. You may be more likely to get the best protection plan at the best rate with best comparing. As different types of plans can be found in the market, it is good to compare them to arrive at an informed choice. In this post, you will learn much more about Aviva ilife and even Aegon Iterm by means of comparison.

Things to Consider While Evaluating Insurance Policies

It is best to ensure that during the time of comparison as to what types of life insurance policy you’re going to purchase. You are supposed to clearly make your choice whether you are going to purchase a universal life insurance or else a low cost term insurance. Please note that whole life insurance lasts for the rest of your life whilst term insurance is ideal for a short time which must be renewed or even you have to purchase new when time comes to an end. If you’re new to insurance policies, exploring the internet would help you getting familiarized with them.

Assess Advantages of Many Insurance Companies

In terms of identifying suitable life insurance policies, making a comparison of their benefits as well quotes can help you a lot. If you’re searching for a term insurance, for instance, then it will be wise to compare at least 3 quotations on the internet and so come to know about rates as well as settlements offered. Do not forget to compare monthly premiums that you need to pay after making your purchase. Be sure that the premium is low as well as in case of universal insurance, the premium is pertaining to the market conditions. Besides comparing premiums, make sure you evaluate prices of whole life insurance with the rates of term life insurance. Right now, a number of insurance companies as well as services offer free life insurance prices which will help you a lot when it comes to making your choice for the right one. It is more better to consult a reliable insurance agent for getting the right policy if you’re not confident.

Examining Aviva ilife and Aegon Iterm

After you look at the insurance market, you will come across lots of options to select from however the best ones are Aviva ilife and Aegon Iterm that you can pick. You can make a good comparison between Aviva ilife plus Aegon Iterm to arrive at the best choice as to what can be done which really can be good to you.

Main Features of Aviva i Life Term Plan:

Aviva iLife protection plan is available for online buy without any sort of agent intervention. It’s actually considered as vanilla term plan with no fringes attached.

* It is Death Benefit only and moreover no Maturity Gain

* Available on the internet for online purchase at selected cities

* Discount available for large Sum Assured

Key Features of Aegon iTerm Plan:

Its among the least expensive term insurance plans, now available for online purchase.

* It is Term Insurance Policy with Death Benefit only

* Among the many cheapest plan in the Indian market available with high non-medical limit

* Available on the internet for online purchase

Before coming to a particular decision pertaining to making your purchase for a particular life insurance policy, you should compare features, benefits, premiums and also rates to get what is best!

Business Analyst In Insurance Domain

The right balance of information and technical knowhow is needed for a Business Analyst to successfully complete his job in any sector. This dictum applies to the Insurance sector as well.

A Business Analyst should be well versed with the information that is needed for any Insurance professional to work in the Insurance domain. Since he has to analyze the processes and then help in the development of essential software for the projects in the Insurance sector, he needs to have both – the information required of an Insurance professional and the technical knowledge required for the establishment of software designed for this sector.

Insurance as is known is generally divided into three major divisions: Life Insurance (dealing with safeguarding life and the risk of mortality and critical illnesses), General Insurance (dealing with the risk of damage to immovable property, motor, cargo, marine, household, and fire insurance), health insurance (dealing with risk of illness and disease, and thus covers reimbursements, medical claims, operation of panel doctors, cashless hospitalization, co payment etc.) The level of knowledge and range required is different in each stream and hence a Business Analyst has to have a certain demonstrable understanding of the workings of the particular streams in the sector and also desirably, adequate level of experience in the sector.
Functional Knowledge of Insurance applications is also essential, like new business, channel management, policy servicing, claims management, underwriting, reinsurance and finance. Along with knowledge of the business processes of the particular client company, a brief and thorough understanding of the requirements given by the regulatory authority of the Insurance industry is also mandatory. The terminology is varied for the Insurance sector, with changes even within the sector, for the different streams of the sector. Knowledge of these unique terminologies will help the Business Analyst to understand the client who is the end user’s expectations and he will be able to draft them better into requirements efficiently.

Once functional requirements are known, the technical knowhow is also essential for any good Business Analyst to communicate to his software developer’s team about the client user’s expectations from the project. The Business Analyst should be aware of the basic MS- Office tools like Microsoft Word, Ms PowerPoint, MS Excel, MS Visio, MS Access, and MS Project). These help in collating data and presenting it in proper format. Then knowledge of relational databases is also important for understanding the technicalities of Querying and Support. Basic programming languages that are used by software developers should also be known to the Business Analyst so that he can understand the developer’s problems or point of view. These programming languages could be ASP, Dot Net, JAVA, J2EE, XNL, HTML etc.

In addition to these, knowledge and experience in insurance business applications, content management systems, portals, data warehousing tools can give any Business Analyst that extra edge over others standing next to him.
Thus, it’s quite clear that a Business Analyst in the Insurance domain needs to know both sides of the coin – the knowledge of insurance business processes and the relevant Insurance software packages.

Pros And Cons Of Critical Illness Insurance

When it comes to purchasing life insurance, there are many different things you have to consider. The price of the policy, what it covers, and the type of coverage are all very important factors. Another factor is critical illness insurance. This is often an extra feature of some insurances that is optional, but is it a good option? That’s the question. There are some obvious benefits to adding critical illness insurance to your policy, but there are also some reasons you may want to pass on it. Either way, you should make certain that you are completely informed about the insurance before making a decision.

Basically, critical illness insurance is a policy that comes into play if you come down with a life-threatening illness. What constitutes a life-threatening illness is defined by the policy and is different for each insurance company. Some have a very short list of illnesses, while others cover up to 30 diseases or more. When you become unable to work due to one of these illnesses, the policy will pay out. Some of these policies pay over a period of time, but many of them pay out a one-time lump sum that is generally tax-free. You are free to use this lump sum to pay for medical procedures not covered by your medical insurance and to handle bills and financial obligations such as your house payment, utilities, etc.

The most obvious benefit is that you get an immediate payout. This means you won’t have to worry about meeting your monthly financial obligations. You may even be able to use the sum to pay off your mortgage or vehicle, thus removing a potential financial obligation from your surviving family members in the event of your death. Your family will also have the finances to handle your funeral arrangements and the various expenses that come with death, something that can put a major financial strain on people.

On the downside, there is the fact that critical illness insurance is an additional cost. If you already have high month-to-month living expenses, it may be difficult to add another type of coverage to your insurance. It’s also possible that your premiums will increase at some point, especially if you start smoking or if you are determined to be overweight. If you’re already in poor health, in fact, you may not be able to get critical illness insurance at all.

Another factor is that those who have a pre-existing medical condition may have that condition specifically excluded from their critical illness policy. Others may have conditions excluded based on the fact that close family members suffer from that condition or the fact that their family has a medical history of the disease. Some critical illness insurance policies have also started excluding certain diseases like basic cases of prostate cancer or some types of skin cancers. This is why it is very important to read every condition and exclusion in the policy before you pay for it. While critical illness insurance can be a life-saver in some situations, in others, it is simply another financial commitment that may not actually help you that much.

How To Handle Your Inheritance Wisely

The receipt or notification of an inheritance is often accompanied by various conflicting emotions. On the one hand, you are happy to except the inheritance, be it a priceless heirloom, an object rich in sentimental value, or a cash windfall. On the other hand, you are faced with the fact that you are receiving this inheritance because someone, and likely someone that you cared very deeply about, has passed on. Mixed in with these sentiments is the urge-in the case of a monetary inheritance-to splurge on something that you have always wanted, be it a new car, a cruise, or an upgraded home.

When faced with all of these feelings and emotions at the same time, you may begin to feel overwhelmed, particularly if you are smart enough to realize that you should be investing at least some of your inheritance, but aren’t sure exactly how to go about it. This article is written with the assumption that you have received (or have been named beneficiary) of a monetary inheritance, and has been written in order to provide you with suggestions for managing said inheritance in a wise fashion. Listed below are five tips for handling your inheritance.

Determine exactly what you currently have, and what you are owed. In most cases, dispersal of your inheritance involves more than just a check from the executor of an estate. Instead, you will likely receive separate monies from individual investments. Usually, you receive these monies on a “stepped-up basis,” which means that the cost bases of the assets are determined as of the date of death. You should also be aware that you won’t necessarily receive all of the assets at the same time. For these reasons, it is essential to sit down with your financial planner and determine exactly what the monetary value of your inheritance is, how it is invested, and what the cost basis is. It is also important to know where the money is coming from, since different types of accounts (like Individual Retirement Accounts or Insurance benefits) have different protocol for withdrawing funds. Remember that this is your money, so don’t be afraid to be proactive and ask for it.

Make a list of your short-term and long-term goals. Of course, it is very tempting to spend sudden windfalls on short term goals such as buying a car, sending children to private school, taking that cruise around the world, etc. What you need to consider before you splurge, however, are your long-term retirement goals, and whether you will be able to sufficiently meet them. This is where your financial planner can be an invaluable asset, as they can work with you to help you develop a plan that provides you with future financial security and hopefully a little splurge room as well.

Decide on exactly how much money you want to use for a splurge. Once your spending plan is in place, and you are able to see how much money is available for meeting your short term goals, the next step is to decide how much of it to use to purchase splurge items. Most experts recommend setting up a separate account for this money. This way, when it is gone, you will be less tempted and able to spend any more of your inheritance.

Put the equivalent of three to six months of regular expenses in an emergency fund: This is something that you and your financial planner should discuss, and it is a potentially life and credit saving strategy in case of any type of emergency. This money should be put into a short-term, fixed-money market account.

Develop an investment strategy for meeting your long term goals: With proper investing, the money that you have set aside to meet your long term goals can grow substantially. While there are many options for investing, here are three that you may want to consider:

Life Insurance: Your long term goals may include providing financial security for your loved ones, and if so, you should consider putting some of your inheritance into a permanent life insurance plan. Life insurance beneficiary proceeds are usually not subject to probate, and permanent life insurance can also offer many living benefits such as tax-deferred cash value accumulation, the ability to borrow from cash value on a tax-free basis, and the eligibility to earn dividends as declared by the insurance company, although it should be pointed out that dividends are not always guaranteed.

Annuities: Many people decide to place their inheritance money in annuities to grow long-term funds for the future. Annuities are flexible, tax-deferred investments that can be used to help achieve long-term goals and provide a source of retirement income. The money in an annuity accumulates tax-deferred, which means that you will only pay taxes on your earnings when the money is withdrawn. You should know, however, that any withdrawals made prior to age 59 ½ may be subject to a 10% IRS penalty tax.

Bonds: There are many different types of bonds available, and your financial institution as well as you financial advisor, can help you decide which bonds are right for your investment purposes. US Government bonds carry some tax deferment benefits, while other types, like mortgage bonds, require higher investment yields but are generally considered more aggressive. The type of bond that you choose should also reflect your investment personality and be consistent with both your short and long term goals.

However tempting it may be to spend your entire inheritance in one fell swoop, remember that the person who provided this inheritance to you did so in hopes that you would use it both wisely, and in their memory. You owe it to this person, as well as to yourself, to spend your inheritance wisely, and your certified financial planner is the person most qualified to help you do so.

Insurance Lead Generation Using Google Adwords

Google AdWords is simple: you make ads which Google shows to the right of regular search results. Your ads appear when somebody researches keywords you’ve selected which you want to be associated with . For example if you have an internet website that sells life insurance, you might want your own ad to look to the correct of Google results when men and women look for insurance protection” or related words.

Different from conventional advertising, you don’t pay Google when it shows your own ad; you pay only when someone clicks your ad. If somebody searches Google for life insurance, Google exhibits your own ad near articles as well as news around life insurance. If someone researches Google for the key words, you know they’re in all probability looking for the offerings. AdWords may thus be the wonderful alternative when you need to direct the ads to the specific audience, such as prospects seeking life insurance. AdWords can be the shape of direct marketing, a lot like direct mail or telemarketing, so which your own content to be presented individually to every possible client.

AdWords might also be an easy option when you have merely the few dollars for reaching your audience and acquiring life insurance leads. Even though AdWords mat be an cost-effective advertising platform, know that there are LOTS of others focusing on popular significant phrases such as “life insurance”. Since AdWords doesn’t bill a set price per ad, you bid on the key words which you need to display your ads as well as those bids are in competition with others (e.g. other insurance professionals). If you bid high than everyone else who bid on the same essential phrase, your ad is likely to show near the top of the sponsored ads. For example , if you set the maximum bid of 45 cents for the word “life insurance”, as well as the following highest bid is actually 33 cents, Google gives the ad priority among the paid ads it shows when someone looks for “life insurance”. But with a popular key phrase such as “life insurance”, probably the top bid will be fifteen dollars per click as well as your bid of forty-five cents will make which your ad is actually never shown.

When deciding who gets top exhibit position among the sponsored ads, Google takes into account the bid and factors the number of individuals who click on each advertisement, giving preference to the a lot more good ads. You cannot, therefore, purchase the top placement unconditionally but your own bid is the most crucial ingredient in determining how a lot of views your own ad gets.

The key when you have fantastic at using AdWords will be uncovering key words where you have inconsequential bid competition however you acquirehave noticeable traffic. As soon as you hit on the hot spot of essential words for the follow, you have a great manner for obtaining leads.

Beneficiary Defective Irrevocable Trusts

The benefits of an intentionally defective grantor trust (“IDGT”) are well known. First, the grantor’s payment of the trust’s income taxes is essentially a tax-free gift to the beneficiaries of the trust. Rev. Rul. 2004-64. Thus, the assets in the trust grow “tax free”. Second, by paying the income taxes, the grantor is reducing his/her estate by the taxes paid and any future appreciation that would otherwise have been generated on the funds used to pay income taxes. Third, the grantor can sell assets to an IDGT (on installments) without any gain or loss recognition. Sales between a grantor and a grantor trust are disregarded for income tax purposes. Rev. Rul. 85-13. Fourth, a sale to an IDGT of a life insurance policy on the grantor’s life can avoid both the three-year rule and the transfer-for-value rule. Rev. Rul. 2007-13. Fifth, an IDGT qualifies as an eligible S corporation shareholder. IRC Section 1361(c)(2)(A)(i). But, at such time as the IDGT is no longer a grantor trust, the trust must then “convert” to a Qualified Subchapter S Trust (“QSST”) or an Electing Small Business Trust (“ESBT”). Finally, with proper design and drafting, grantor trust status can be “toggled” on and off for maximum flexibility.

The powers that are typically used to trigger grantor trust status for income tax purposes, but without causing inclusion of the trust’s assets in the grantor’s estate, are the following:

1. The power to substitute trust property with other property of equivalent value. IRC Section 675(4)(c).

2. The power in a non-adverse party to add charitable beneficiaries. IRC Section 674(b)(4).

3. The power to distribute income to the grantor’s spouse. IRC Section 677(a)(1) and (2).

4. The power to use trust income to pay premiums on policies of insurance on the life of the grantor or grantor’s spouse. IRC Section 677(a)(3).

5. The power of the grantor to borrow trust assets without adequate security. IRC Section 675(3).

That said, consider turning the tables and drafting the trust so that the beneficiary – and not the grantor – is taxed on the trust income. With an IDGT, the grantor cannot be a beneficiary or a trustee of the trust without adverse estate tax consequences (under IRC Sections 2036 and 2038). But, with a beneficiary defective irrevocable trust (“BDIT”), the beneficiary can be both the primary beneficiary and the trustee of the trust. The reason is that the beneficiary is not the grantor of the trust. Instead, the grantor is usually the beneficiary’s parent or grandparent.

Although it may not be cited as precedent, PLR 200949012 provides planners with a road map on how to properly design a BDIT. Following are the facts in PLR 200949012:

1. The grantor proposes to create a trust for the benefit of beneficiary;

2. The beneficiary will be a co-trustee of the trust (along with two independent co-trustees);

3. The beneficiary will have the unilateral power to withdraw all contributions made to the trust. However, this power will lapse each calendar year in an amount equal to the greater of $5,000 or 5% of the value of the trust.

4. The beneficiary will also have the power, during his lifetime, to direct the net income and/or principal of the trust to be paid over or applied for his health, education, maintenance and support (“HEMS”), and this power will not lapse;

5. The beneficiary will have a testamentary limited (non-general) power of appointment to “re-write” the disposition of the trust assets upon his death;

6. The trust provides that neither the grantor nor the grantor’s spouse may act as a trustee, and that no more than one-half of the trustees may be related or subordinate to the grantor within the meaning of IRC Section 672(c); and

7. The trust contains various provisions assuring that the grantor will not be treated as the owner of the trust for income tax purposes under IRC Sections 671 – 679.

The IRS ruled that the trust did not contain any provisions that would cause the grantor to be considered the owner of the trust for income tax purposes. Instead, the IRS ruled that the beneficiary will be treated as the owner of the trust for income tax purposes – before and after the lapse of the beneficiary’s withdrawal rights. The IRS analysis was as follows:

1. The trust did not contain any grantor trust “triggers” under IRC Sections 673 (reversionary interests); 674 (power to control beneficial enjoyment); 675 (administrative powers); 676 (power to revoke); 677 (income for benefit of grantor); or 679 (foreign trusts).

2. Under IRC Section 678, the beneficiary will be treated as the owner because the beneficiary had the right exercisable solely by the beneficiary to vest trust principal or income in himself.

In order for a beneficiary to be deemed the owner of a trust (for income tax purposes) under IRC Section 678, the beneficiary must be given the unilateral right to withdraw all income or corpus from the trust and, if such power is “partially released”, after the release the beneficiary retains such an interest in the trust that it would be a grantor trust with respect to the real grantor (if the real grantor had retained such interest). But, when the power gradually lapses in its entirety (by $5,000 / 5% per year), is IRC Section 678 status lost? According to PLR 200949012, the answer is “no”. The ruling apparently treats a “lapse” as a “release” so that even if the unilateral right to withdraw eventually disappears (by $5,000 / 5% per year), the lapse would be partial only because the power to withdraw for HEMS remains. And the HEMS standard – if available to the grantor – would be a grantor trust trigger under IRC Section 677. Thus, under IRC Section 678, the beneficiary continues to be treated as the owner of the trust.

As to the beneficiary’s estate tax consequences, the power to withdraw trust assets for HEMS does not create a general power of appointment and, therefore, does not result in estate tax inclusion. IRC Section 2041(b)(1). But, the unilateral right to withdraw principal is a general power of appointment that will cause the trust assets to be taxed in the beneficiary’s estate (but only to the extent the power has not lapsed under the $5,000 / 5% rule). IRC Section 2041(b)(2). For example, if the grantor contributed $1 million to the BDIT, the unilateral power of withdrawal would lapse in 20 years (i.e., 5% x $1 million = $50,000), or even sooner if the trust assets grew in value.

A BDIT works particularly well where the beneficiary has a new business opportunity, but would like to keep the business out of his or her estate. The beneficiary convinces his/her parents or grandparents to give him/her an “advance” on his/her inheritance by making a gift to the BDIT. This will allow the beneficiary to operate the business (as the trustee of the BDIT). The beneficiary will also have access to the cash flow of the business, without inclusion in his/her estate (except to the extent the beneficiary’s unilateral withdrawal right has not yet lapsed under the 5% / $5,000 power). The beneficiary can also sell assets to the BDIT without any gain or loss recognition. Finally, the beneficiary’s payment of the BDIT’s income taxes reduces his/her estate and is a “tax-free” gift to the remaindermen of the BDIT (i.e., the beneficiary’s descendants).

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.