Life insurance has become virtually ubiquitous in wealth planning. It is flexible, can be adapted to a wide range of purposes, enjoys very favourable tax treatment in most if not all jurisdictions and is virtually universally recognised. Life insurance can be used to preserve and increase wealth as well as pass it on to the next generation in a very tax-efficient manner. The main benefits are taken in turn.
5.1. Inheritance and succession planning
Life insurance can enable the tax-efficient transfer of wealth from the older generation to the younger without the need for estate executors. It can under certain circumstances bypass forced heirship laws by removing the assets from the policyholders estate (the assets become the property of the insurer), though this depends on jurisdiction. Furthermore, legal disputes are rarer, it is exceedingly difficult to attack a life insurance policy, particularly a Swiss policy. Done properly it can be very cost-efficient.
Circumvention of forced heirship laws is possible in some jurisdictions as the policy is not included in the estate. For a European citizen with US Assets, this means no estate tax payable on US situs asset on the death of the insured person. For a US person, a trust owned life insurance policy can eliminate probate, both simplifying the process and saving on associated costs1. Furthermore insurance solutions can substantially reduce the impact of estate tax up to complete circumvention.
Transfer of assets to the next generation on the death of either policyholder or insured person can be greatly simplified. Because at the time of death of the policyholder, the assets contained within the policy do not form part of the estate, those assets are not subject to forced heirship laws. This alone makes insurance a particularly elegant solution for people wishing to arrange their affairs. In particular those wishing to define clearly and privately the "Who gets What?" question. One of the big problems in succession is agreeing on "What did Dad say?" and "What did Dad want?" after the fact when Dad is no longer around. Using insurance, Dad can define exactly what he wants before he goes. Furthermore, Dad can define it privately and confidentially. Beneficiaries can be children from 1st, 2nd (3rd...) marriage or children out of wedlock who might otherwise have been excluded. Benefits to wife (wives...), girlfriend(s), nieces, nephews, foundations, trusts, limited liability companies can all be contractually defined and most importantly – enforceable in a court of law. The possibilities are very wide. The enormous flexibility of insurance makes us real fans of insurance – when properly planned and set up. Moreover, participants are bound by bank and insurance secrecy and may not give out any information on a policyholder whatsoever. In Switzerland the insurance company is prohibited by law from disclosing any information whatsoever to anyone, including governmental authorities. They may not even confirm if a particular person has a policy or not. Even the policyholder is unable to direct disclosure to 3rd parties. Should the policyholder himself request the insurance company to divulge his ownership of a policy to a 3rd party, the insurance company must refuse this request2. This can be particularly useful in case of duress.
5.2. Investment tool and control – investment direction
The policy holder has a very flexible choice of investments, virtually any bankable asset (and an astonishing range of non-bankable assets) can be "wrapped". Essentially:
- The policyholder selects a broad investment strategy
- Asset manager has a discretionary mandate to manage the assets
- The asset manager is usually designated by policyholder but actually hired by the insurer
- A "Chinese Wall" to prevent direct communication between policyholder and investment manager is typically contractually agreed
Swiss and Liechtenstein insurance laws stipulate that contracts in which the policyholder bears the investment risk, the insurance company can in principle make use of any investment for which the policy holder is willing to accept the risk. The policyholder thus participates directly in the development of the investment. The insurance carrier sets up a depot account with the custodian bank for each individual policy, allowing individual assets to be assigned directly to individual policies. The policyholder can determine the investment strategy, designate the asset manager to implement the strategy. The asset manager implements the desired investment strategy in the account, the policyholders wishes may range from:
- A conservative fixed income portfolio
- 100% listed equity
- A private equity portfolio
- Hedge funds
- Structured products
- Alternative investments
- Real estate
and virtually any combination of the above.
In general the policyholder is prohibited from making investment decisions himself, he may only define strategy and designate the asset manager. This is known as the owner-control rules. The tax advantages considerably improve the return on investments while at the same time giving the policyholder and asset manager the freedom to select investment instruments without having to consider individual taxation circumstances.
5.3. Asset Protection
The key is that legal title to the assets – ownership – passes from the policyholder to the insurance company. Essentially, the assets underlying the policy cannot be attached or accessed by a creditor or other claimant in a legal process. I.e., if the policyholder is sued, the plaintiff cannot get at the assets wrapped in the policy. A Swiss or Liechtenstein insurance policy will give an extraordinary level of asset protection if it meets the following conditions:
- The policyholder designates his spouse or descendants (i.e. children) as beneficiaries, or
- The policyholder designates anyone as an irrevocable beneficiary, and
- Designation of beneficiary occurred more than 12 months prior to bankruptcy proceedings or the seizure of assets, and;
- The designation of beneficiary was not made with the intent to damage creditors.
There are three main cases:
1. Asset Protection in case of bankruptcy
- The insurance policy will be protected by Swiss law against any debt collection procedures instituted by the creditors of the policy owner and will also not be included in any Swiss bankruptcy procedure in this regard.
2. Protection in case of a foreign judgment
- Even where a foreign judgment or court order expressly decrees the seizure of such policy, or its inclusion in the estate in bankruptcy, such an insurance policy may not be seized in Switzerland or included in the estate in bankruptcy.
3. Protection under duress
- If an insurer receives a letter from the policyholder revoking the beneficiary designation, the insurer may come to the conclusion that the instruction received from the policyholder does not express the policyholders true intent and was forced upon him by the foreign judge or court.
Swiss and Liechtenstein law are virtually identical in this regard. Liechtenstein financial laws were originally derived from Swiss banking and insurance laws. Since Swiss insurance law has been adopted by Liechtenstein back in 1941, investors investing in Liechtenstein insurance policies enjoy the same level of asset protection.
A non-Swiss resident (the policyholder) may purchase a life insurance policy from a Swiss insurance company and designate his/her spouse and/or descendants as beneficiaries of the policy, or irrevocably designate any other third party (for instance, a legal entity such as a trust) as a beneficiary. It is important to note that most jurisdictions allow the surrender (cashing in) of the policy at any time. Surrender penalties usually only apply if the policy has been poorly set up. Should the policyholder need the cash, the policy can be surrendered without penalty. If the beneficiary is revocable, the policyholder need only put in the surrender request with the insurance company. If the beneficiary is irrevocable, the irrevocable beneficiaries signature is needed to cash in the policy. Furthermore the policyholder can borrow against the value of the policy (policy loan). The amount that can be borrowed against the policy is generally around 80% of the cash value.
Swiss law protects the insurance policy against any debt-collection procedures initiated by the policyholder's creditors and excludes it from any Swiss bankruptcy procedures. Even if a foreign judgment or court order expressly decrees the seizure of the policy or its inclusion in the estate in bankruptcy, the policy may not be seized in Switzerland or included in the estate of the bankrupt
party. Unlike the designation of another third party as a beneficiary, in the case where a spouse and/or descendants are so designated, it is irrelevant whether the designation is irrevocable or revocable. The insurance policy will continue to be protected from the policyholder's creditors even if the designation of the spouse and/or descendants is revocable.
5.4. Tax planning and optimisation
Every jurisdiction has its own rules and varying treatments on taxation of life insurance. One more source of variation that makes this all so confusing and competent tax counsel essential. The following is a generalisation of tax benefits, for specific jurisdictions, local tax counsel must be consulted.
A properly structured insurance contract can provide significant tax advantages in most cases. Insurance can offer significant relief from income and inheritance taxes. In order to benefit from tax advantages, the life insurance policy must comply with the tax regulations in the policyholders country of residence. For example, a certain minimum term may be required or the insurance must include a certain amount of life cover (risk shift) with the investment component. Income (dividends, interest, etc.) and capital gains on assets placed in a life insurance policy are generally tax-free. Often the policy proceeds are tax free, i.e., the proceeds are paid net to the beneficiary. The assets paid into a life insurance policy do not constitute a gift as they are generally treated as a premium payment. Furthermore, these assets do not generally form part of the policyholder's estate for inheritance or wealth tax purposes, since the nature of the policyholders interest in the assets is not that of an owner but the holder of an insurance policy. On maturity of the policy, capital gains may be tax-free in many countries, or taxed at a very low rate. Under Swiss law, both variable and fixed annuities are treated as life insurance policies and are consequently exempt from Swiss income and asset taxes. Swiss life insurance and annuities are also exempt from the 35% federal withholding tax. If issued in Switzerland, Swiss life insurance is exempt from the one per cent US excise tax on the purchase of foreign annuity and insurance premiums. This exemption derives from the Swiss-US Double Tax Treaty signed in 1998 and applies to premiums paid by a US citizen to an insurance company domiciled in Switzerland. Lastly, assets in an insurance policy in Switzerland or Liechtenstein are exempt from the EU withholding tax on EU residents. Generally, this saving alone covers the extra annual costs associated with the policy.
In general, a life insurance policy enjoys full tax deferral during buildup - no tax on income or capital gains on assets in the portfolio during the accumulation period. On maturity of the policy, the payout is split into two; principal and gain. The gain is generally taxed at either the beneficiaries marginal rate or a reduced rate on payout. In many jurisdictions, if the benefit is paid upon the death of the insured person, the beneficiaries receive the full payout (principal and gain) tax-free. This is one of the main attractions of life insurance; for succession planning, properly set up, the entire payout when the insured event takes place can be completely free of tax.
1 As anyone who has had to go through a probate process will know, the costs can be considerable, in time, money and nerves. This alone can make a good insurance strategy worth its weight in gold.
2 This is still the case and airtight. Unlike Swiss banking secrecy which is looking a lot less secret in the wake of the UBS debacle and other cases. 4,450 Clients, full account details, disclosure approved by the regulatory authorities?!?!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.