For Non-Citizen, Non-Resident Aliens (NCNR), acquiring life insurance from a U.S. carrier could potentially have significant benefits. But watch out for the traps along the way.
BENEFITS OF A NCNR OWING A U.S. LIFE INSURANCE POLICY
- Costs. The U.S. has over 800 operating life insurance carriers, actively competing for their share of the market. This, along with higher longevity and thus lower mortality rates than many foreign countries, makes the cost of policies from U.S. carriers amongst the lowest worldwide;
- Stability. The U.S. economy and the U.S. dollar offer significant stability for many NCNRs from less stable countries. Having assets in U.S. dollars often provides considerable asset protection against currency volatility in the NCNR’s home country. If the policy is acquired for inter-generational wealth transfer, the internal rate of return (IRR) on the policy is in most cases significantly higher than owning U.S. Treasuries or other low risk assets. Furthermore, U.S. Life insurance companies are among some of the highest rated financial institutions in the world, some dating back over 150 years, with no U.S. life insurance company ever failing to pay a death claim due to insolvency.
- Tax Laws. U.S. tax laws allow for death benefits to pass income tax-free, and if properly owned and funded, free from any estate and gift taxes. If the policy is also properly structured (avoidance of a Modified Endowment Contract or MEC) the policy’s cash value can be accessed through basis withdrawals or borrowings without income tax being paid on any inside gain.
- Forced Heirship. Many countries still require forced distribution of assets at death according to strict laws and regulations. Ownership of U.S. life insurance policies allows for assets to be more equitably passed on to heirs, in ways that cannot be done in the NCNR’s home country.
- Privacy. Many NCNRs are reluctant to divulge their full financial situation to local agents or insurance companies. Using a U.S. carrier will provide them with levels of privacy unavailable in their home country.
RULES, REGULATIONS AND TRAPS
Who is a NCNR and Why Does it Matter?
- A NCNR will be taxed for gift or estate tax purposes only on their U.S. situs tangible property at the time the gift is made, or at death. A life insurance policy issued by a U.S. carrier and owned by a NCNR is considered under the Internal Revenue Code to be an intangible asset, and hence not subject to either gift or estate tax to the NCNR or his/her estate.
- The qualification tests for a NCNR for purposes of estate and gift tax can be somewhat subjective, and hence, it becomes important to understand how to avoid a policy-owner being classified as a resident for transfer tax purposes. Instead of a “Residency” test used for income tax purposes (which is fairly objective), the transfer tax rules use the “Domicile” test. This takes into account “intent” which can be difficult to ascertain. The IRS will, among other tests, look at how long the individual spends in the U.S. annually, the number and relative size of the individual’s residences in the U.S. and abroad, the individual’s contacts and relationships in the U.S., banking relationships, business interests and location of family members.
- Accordingly, an individual is a NCNR and not subject to gift or estate tax on a U.S. issued life insurance policy if he or she is not a U.S. Citizen, not a permanent resident (Green Card holder) and not domiciled in the U.S
Life Insurer Rules:
Not every U.S. carrier will market and sell policies to a NCNR. Those that do have their own set of rules as to:
- NCNR’s country of permanent residence. Many countries are considered by U.S. carriers as too dangerous or the risks too high to issue a policy on its citizens. Each carrier will include or exclude foreign nationals from certain countries, or sometimes areas of certain countries.
- Each carrier will additionally determine their own set of “nexus” requirements, that is, the degree to which the NCNR has sufficient connection to the U.S. to warrant that carrier providing the coverage. Certain carriers require strong association, like residences, business interests, banking relationships, immediate family members resident in the U.S., while others might be inclined to issue a policy with weaker nexus requirements.
- For all carriers, the solicitation and underwriting rules for insuring a qualifying NCNR are the very much the same:
- The insured must be solicited for coverage in the U.S. Discussion of any particular product cannot be made in the NCNR’s home country;
- The insured must undergo his/her medical exam in the U.S.;
- All application paperwork must be signed in the U.S. and the policy delivery must occur stateside;
- It should also be noted that not all countries will allow their citizens to own a life insurance policy issued by a foreign carrier, and some countries on this list may be surprising. These include, but are not limited to: Argentina, Belgium, France, Greece, Japan, Panama, Poland, Switzerland, Uruguay, and Venezuela.
- Liquidity: As with U.S. Citizens, an NCNR might use a life insurance policy for purposes of liquidity to pay estate taxes on real or other tangible property owned in the U.S. at the time of his/her death. As previously noted, if the policy is owned by the NCNR, the proceeds would not be includable in their estate at death. Wealth Transfer/Asset Allocation: A U.S. issued life insurance policy can be used by NCNRs wishing to use the strength and stability of the U.S. economy as an “asset allocation” component of their overall wealth transfer plan. The relatively very low risk of a strong U.S. carrier and the relative high yields make life insurance a particularly attractive asset alternative.
- As an Alternative to a QDOT: NCNRs with significant U.S. assets subject to estate tax will generally want to avoid the extremely restrictive and administratively cumbersome provisions of a Qualified Domestic Trust (QDOT) when leaving their assets to a NCNR spouse. Since a QDOT merely postpones the estate tax anyway, the use of a U.S. life insurance policy on the NCNR to provide the spouse with necessary support post-demise of the insured NCNR offers a flexible and cost-effective way around the QDOT.
- Pre-Immigration Planning: Prior to immigrating to the U.S. and becoming a resident, a NCNR can transfer assets into a self-settled irrevocable trust. The trustee can use these assets to buy a specially engineered, over-funded life insurance policy. As long as the policy is not a Modified Endowment Contract (MEC), the policy cash value can be used for purposes of living benefits for the now-U.S. resident NCNR, without income tax consequences, while the death benefit would remain estate tax-free at death of the insured.
Non-Citizen, Non-Resident Alien life insurance planning using a U.S. life insurance policy can have great economic and tax benefits. But it also comes with a significant amount of complexity. If you have any clients considering the use of a U.S. Life Insurance policy, we’re available to help in any way, with no obligation or cost to your client.