Succession on Your Terms

Dealers are using irrevocable life insurance trusts and the insurance policies that fund them to ensure succession on their terms.

Planning your business succession is more than executing a financial transaction or negotiating the buying and selling of company ownership. Just as important is managing the transition, protecting company assets and making sure they will be distributed as you want them distributed. Also important to many dealers is the “fair” treatment of all of their children/grandchildren.

To ensure succession on their terms, many dealers are using irrevocable life insurance trusts. Essentially the trust buys life insurance on the dealer (and/or the dealer’s spouse) which provides the cash to pay any estate taxes and cover expenses in distributing your assets at death.  Often these trusts are being utilized to “balance out” the estate between those children involved in the dealership and those that are not involved.  In many situations, the children involved in the dealership receive the dealership (and control of the underlying real estate) while those children not involved in the dealership receive the proceeds (or a larger portion of the proceeds) of the insurance policy.

These policies are owned inside of the trust for many reasons: financial and non-financial.  Since these policies are owned inside a trust a trustee must be assigned. Sometimes these are professionals but often they are family members or friends. Either way, trustees often fail to review the insurance policies inside the trust, that is, ensure that they continue to perform well enough to achieve the goals of the trust. A survey of trustees found that 83 percent of professional trustees had no guidelines for reviewing policies inside the trust, and 71 percent of family or friend trustees had not reviewed the policies within the past five years. This can be a tragic oversight, as frequently the policies are counted on to provide nearly all the liquidity associated with transitioning the company and counted on by your beneficiaries, others as well as your successor.

Trust life insurance policies should be reviewed with the same scrutiny as trust investments. For example, a policy purchased to fund federal estate taxes might no longer be necessary in light of the increasing exemption amounts (currently $5.45 million, twice that for husband and wife). Assuming the policy is still needed for estate or other family wealth transfer purposes the policy may not be performing as originally projected.  Accordingly, premiums might need to be increased or could be reduced. There are numerous types of policies and they all have complicated terms and are governed by complex rules. As such it is important to have an independent insurance expert regularly review your trust policies.

We recently met with Mark Leyden, an insurance advisor who frequently works with dealers, we recommend the following be examined in a policy review:

  • Objective: What was the purpose of the policy at origination and has that changed?
  • Premiums: Are they adequate to support the policy during its life expectancy? In some cases, premiums will need to be increased to provide sufficient coverage to address your goals. Are premiums being paid in a timely manner? Without proper attention, policies could lapse. If a policy lapses, there is no benefit, and, not incidentally, this would likely be grounds for a lawsuit against the trustee.
  • Death benefit: Is the benefit amount appropriate to address your current business and financial situation?
  • Health status: Is the insured’s ability to obtain a new policy in question due to declining health? Alternately, treatments for certain conditions have improved to the point that insurance underwriters have adjusted premiums downward which means that a new policy may provide the same benefits at a significantly reduced cost.
  • Market conditions: Insurance is a very competitive business. You might be able to increase death benefits without an increase in premium simply because of favorable market pressures.

To ensure trust policies remain relevant to your needs, conduct a review every three years. Include these five steps in your review:

  1. Request an inforce ledger or illustration from insurance company, which shows a policy’s future premiums, cash value and death benefits. The ledger will help evaluate the adequacy of your premium and reveal whether a lapse is imminent.
  2. Locate the policy origination form, which indicates the basis for purchase at the policy’s issuance date.
  3. Conduct a marketplace review, comparing your existing policy to a newer policy. We have seen dealers able to increase the death benefit by 40 percent without a premium increase.
  4. Confirm the financial health of the insurer. Its strength is critical to its ability to live up to the policy’s promise.
  5. Review your estate plan to ensure the trust and insurance accommodate your current estate plan.

Trustees, both individual and corporate, have fiduciary obligations to manage the insurance policies inside the trust. Regular policy reviews are an important part of that responsibility.

About the Author(s)
Rex is a Principal of HBK CPAs & Consultants and directs the firm’s Dealership Group. He has worked extensively in the dealership industry since 1984 as a department manager, a general manager and an owner, as well as providing tax, accounting and operational consulting services exclusively to dealers as an independent CPA. This experience includes working closely with hundreds of dealers from coast-to-coast since 1987 on creative tax planning and financial statements issues. He provides clients with a wide range of transaction work services, and consults for them in specialty areas such as operations, government regulatory compliance, valuations and M&A feasibility studies. Rex is active in many professional associations. He is the current Chairman of the BDO Dealership Industry Group, contributes articles and commentary to dealership industry publications, is frequently called upon to speak to industry associations and conferences, provides expert testimony, and is regularly quoted by industry and the general media.
Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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