What is a waterfall concept?
A joint estate planning technique known as the “waterfall concept” involves transferring, or “rolling over,” a whole life insurance policy from the policyholder to their child or grandchild.
How Concepts of Waterfall Operate
The waterfall idea intends to ensure that money is transferred as tax-efficiently as possible from generation to generation. It does this by designing a tax-exempt whole-life insurance policy such that, upon the death of the original policyholder, the child or grandchild may later receive the policy’s tax-deferred cash value.
There are two parts to whole-life policies. Whole-life life insurance plans build up a tax-deferred cash value while the insured pays premiums on top of the death benefit upon the insured’s death. The funds become taxable upon withdrawal when the insured person passes the life insurance policy to a descendant.
The waterfall approach has tax benefits but also helps avoid some of the difficulties associated with gifts and other large-scale asset transfers. For instance, waterfall ideas may be implemented using only the original insurance contract’s terms and conditions without the need for potentially expensive attorneys and intermediaries. Using the waterfall approach to transfer money may prevent assets from being distributed to other parties throughout the probate process.
How Waterfall Concepts Work
The cascade notion is best shown by examining a situation where a grandmother transfers the policy to a grandson. The grandchild would only have to pay taxes on money withdrawn from the insurance at that point. Overall, tax savings would arise from the grandchild’s lower tax rate than their grandmother’s.
It’s crucial to design the policy to guard against the possibility that the original policyholder would pass away before transferring the procedure while using the waterfall idea. One way to do this is to name a third person as a contingent or irrevocable beneficiary, such as the child’s parent, with the understanding that the parent would transfer the insurance to the grandchild upon the grandchild’s legal adulthood. The wording of the life insurance policy itself might be used to fully specify this procedure without the need for a trust or other similar legal organization.
Conclusion
- The waterfall idea is an estate planning technique that effectively transfers money across generations by using whole-life insurance policies.
- It can only be used when a grandparent gives money to their kid or grandchild or when wealth is transferred from an older generation to a younger one.
- Waterfall principles have tax advantages but may also lower legal expenses and probate problems.
