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A Smart Solution to Accumulation Distribution


High net worth individuals looking to protect their assets from taxation are often faced with a variety of challenging decisions. They know the end result they want to achieve, but the processes and options at their disposal can often feel like they’re written in a foreign language.

Matthew Ledvina


To give you some food for thought we’re going to take a look at the issue of accumulation distribution: what it is, why it occurs, and how to solve it. That way you’ll be able to make an informed decision that will stand the test of time.

What is Accumulation?
High net worth individuals will commonly set up Foreign Non-Grantor Trusts (FNGTs). These are legal tools that allow a non-US citizen to transfer their income to a US beneficiary in a safe and secure way. A common example of this would be a high net worth parent looking to financially support a child or relative living in the US. Whilst FGNTs have a number of attractive benefits, they can also have their downsides if not structured correctly.

The wise approach is to pay out net income each year to the beneficiary so as to minimize the impact of the US tax system. Issues can arise when this is not always possible, resulting in some of the income remaining in the trust. This is referred to as accumulation, and it can result in large, unforeseen additional interest charges if proper planning is not in place.

Why Might Accumulation Occur?
Accumulation could occur for a whole host of reasons including: poor planning, a delay in payments, working to reduce that year’s taxable income for the beneficiaries as well as a whole host of things which will be specific to your personal circumstances.

The key take home point here is that when the accumulated income is eventually paid out to the beneficiary, it will be subject to what is often called a ‘throwback tax.’ This effectively taxes the beneficiary at exactly the same rate as if the income had been fully distributed by  the end of each tax year. The downside is that this can leave a large hole in annual budgeting and completely strip capital gains of the favorable aspects that made them so appealing in the first place. So, what can you do about it?

Solving the Accumulation Distribution Problem: Private Placement Life Insurance (PPLI)
Before we get started, we should say that PPLI cannot be used to solve the issues caused by existing accumulation issues in a FNGT. It’s designed specifically to address future issues, making it a wise choice to consider when you want to future proof your financial arrangements in a way that legally protects them from the US tax system.

There are a variety of different ways you could implement PPLI, one of the most common of which is investing in a Non-Modified Endowment Contract (non-MEC). Whilst the technical details of such an arrangement are beyond the scope of an introductory article, the key benefits are clear for all to see. Here are 4 key channels which are not treated as taxable income under a non-MEC arrangement:

-    Death benefit proceeds such as inheritances and assets left to you in a will
-    Policy loans and other such arrangements
-    Withdrawals all the way up to a pre-stated premium
-    Any income or investment returns that are housed inside the policy

The specific arrangements of a non-MEC approach will depend on your individual circumstances, and will hinge on issues such as the level of your assets, residency status and immigration status. As with every aspect of complex financial planning, it is always recommended to start planning as early as possible, and to always seek the advice, guidance and expertise of an experienced legal professional.

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