Planning for Foreign Beneficiaries: Understanding the U.S. Life Insurance Market Landscape

Planning for Foreign Beneficiaries: Understanding the U.S. Life Insurance Market Landscape

Navigating the world of life insurance can be complex, especially when planning for foreign beneficiaries. The U.S. life insurance market, with its unique structure and regulations, presents a different set of challenges compared to other regions. Understanding these intricacies is crucial for effective wealth transfer and ensuring that beneficiaries, regardless of their location, receive the full benefits of planning.

3 Key Differences Between the U.S. Insurance Industry and Other Parts of the World

Life insurance markets vary significantly across the globe. In the U.S., the market is characterised by a high degree of regulation, a wide array of product options, and specific tax implications. For example:

1. Regulation: U.S. life insurance is regulated at the state level, leading to a complex patchwork of rules that can differ from state to state. This contrasts with many other countries where national regulations provide a more uniform framework.
2. Product Variety: The U.S. offers a diverse range of life insurance products, each with competitive features, such as no-lapse guarantee in indexed universal life and variable life policies, which are less common in other markets.
3. Product Types: Indexed and Variable universal life insurance products, with their cash value components, might offer advantages in terms of wealth accumulation and transfer. However, the complexity of these products requires careful planning to ensure they align with the needs of foreign beneficiaries.

Insights into U.S.-Based Life Insurance Products and Their Suitability for Foreign Beneficiaries

When considering U.S.-based life insurance for foreign beneficiaries, several factors come into play:

1. Beneficiary Designation: Foreign beneficiaries might face different tax implications upon receiving death benefits. It's essential to understand whether the policy's proceeds will be subject to U.S. estate taxes or other tax treatments.
2. Policy Types: Universal life insurance policies, with their cash value components, might offer advantages in terms of wealth accumulation and transfer. However, the complexity of these policies requires careful planning to ensure they align with the needs of foreign beneficiaries.
3. Cross-Border Taxation: Double taxation treaties between the U.S. and other countries can impact the tax treatment of life insurance benefits. Advanced planning can help mitigate these issues by structuring policies in a way that takes advantage of tax treaties and reduces the risk of double taxation.

Case Study: Creating a Lasting Legacy for U.S. Beneficiaries

An affluent U.S. citizen residing in Hong Kong, Mr. Smith, wanted to leave a significant portion of his estate to his children living in the U.S. He would like to purchase a large life insurance policy with substantial cash value as part of his estate planning strategy.

Key Challenges Faced and Solutions Implemented

Challenge #1: Lifetime Taxation of Policy
In deciding between purchasing a local Hong Kong policy or a policy from a U.S. insurer,  Mr Smith was concerned about how the policy's cash value and death benefits would be taxed in both the U.S. and Hong Kong.

Solution: An U.S. tax attorney recommended that since Mr Smith is a U.S. citizen, he should consider purchasing a “U.S. compliant” policy* issued by a U.S. insurer, instead of a local Hong Kong policy which is not U.S. compliant.  This ensures that the cash value of the policy is U.S. income tax-deferred.  The Howden Private Wealth (HPW) Consultant was able to help structure the policy as a non-modified endowment contract to ensure more tax-efficient lifetime withdrawals from the policy, if ever required. 

Challenge #2: U.S. Estate Tax Implications
Since Mr. Smith is a U.S. citizen, he was concerned about potential U.S. estate taxes of up to 40% on his life insurance policy proceeds, which could significantly reduce the benefits received by his children.

Solution: As the U.S. lifetime gift and estate tax exemption of USD 13.6m is slated to reduce by half to USD 6m by the end of 2025,  the tax attorney recommended that Mr Smith uses part of this allowance to fund an Irrevocable Life Insurance Trust (ILIT) to purchase the policy.  This move excluded the policy from Mr. Smith's estate, thereby avoiding U.S. estate taxes on the policy's death benefit (which is significantly larger than its current cash value) when Mr Smith eventually passes. 

Challenge #3: A Whole-of-Life Solution
Mr. Smith has heard about the possibility of a life insurance policy “lapsing” in Hong Kong.  He was therefore concerned that the life insurance product he had chosen would not be able to cover him for the whole of his life, especially in view of longer life expectancies. 

Solution: The HPW Consultant recommended that Mr Smith consider a no lapse guarantee (NLG) variable universal life insurance policy issued by a U.S. insurer with flexible premium payments and investment options.   This provided Mr Smith with the peace of mind knowing that his children is guaranteed the policy’s death benefit even if Mr Smith were to live beyond the age of 100 years old. 

3 Key Success Factors

1. Selection of a U.S. compliant policy: Instead of simply purchasing a local Hong Kong policy,  Mr Smith was able to procure a U.S. compliant policy through HPW. This ensures that his policy’s cash value can grow annually in an U.S. income tax efficient manner.
2. Use of an ILIT: By structuring the ownership of the policy under an ILIT, Mr. Smith successfully removed it from his estate, thus avoiding significant estate taxes and ensuring that the full value of the policy was preserved for his beneficiaries.
3. U.S. policy with a NLG feature: The selection of a U.S. compliant NLG policy, which is unavailable in the local Hong Kong market, ensures that Mr Smith’s beneficiaries would be guaranteed a death benefit regardless of when Mr Smith passes away. 

Understanding the U.S. life insurance market landscape is crucial for effective estate planning, especially when foreign beneficiaries are involved. By addressing regulatory differences, product suitability, and tax implications through advanced planning and professional guidance, individuals can navigate this complex landscape and ensure a smooth, tax-efficient transfer of wealth to their loved ones.

*The policy fulfils the definition of a life insurance policy stated in Section 7702(a) of the U.S. Internal Revenue Code. 

Andrew Wong
Vice President, Products and Operations
U.S. Office
agwong@howdengroup.com