Irrevocable Assets and the Loss of Basis Step-Up

Our insurance team was one of a number of coordinating advisors that participated in a holistic client portfolio review. The client holds a considerable amount of assets in irrevocable trusts outside of their estate. Although they planned well and strategically transferred assets into irrevocable trusts, they will not receive a basis step-up at death. At historically reliable rates of return, this will lead to millions of dollars in gains that would otherwise be zeroed out with a step-up in basis.

We explored two options to synthetically create a step-up in basis for greater tax efficiency.

The first option is a private placement life insurance policy (PPLI). In this policy design, clients contribute assets to a privately underwritten variable universal life insurance policy (VUL). The value of this policy is that all gains and income are tax-deferred and typically tax-free. In fact, the client’s least tax-efficient assets (hedge funds) are allowable holdings inside this structure. Dividends, distributions, income, and gains are all tax-deferred and tax-free. Since death benefits are tax-free, it stands in place of a step-up in basis and acts the same way.

The other option is a traditional VUL. This works much like PPLI but is made up of sub-accounts that act like mutual funds. In this case, our team professionally manages the asset allocation of the funds inside the VUL. All forms of dividends, distributions, income, and gains are tax-deferred and tax-free as long as the policy remains in place.

In the end the client decided to go with a traditional VUL, managed by our analysts, because the fee structure allowed more potential for cash accumulation in later years and a higher chance of an increasing death benefit. In addition, the client will receive streamlined access to the cash value of the policy in a traditional VUL.

Key Takeaways

In the absence of a step-up provision, a strategically placed life insurance policy may be a valuable tool that adds income and estate tax efficiency, access to cash, and flexibility.