Wealth managers face unique challenges when advising US clients living outside the US or those with US connections. In the presence of a US nexus, even otherwise basic estate plans require additional analysis because of the worldwide reach of the US tax and regulatory framework. However, the complexity of these challenges opens up opportunities for advisors to offer clarity and simplicity for such clients. In this article, Danilo Santucci, senior US tax counsel and wealth planner at Lombard International Assurance, looks at the common concerns of US connected clients and delves into the available solutions.

Common concerns

Consider John Smith, a US citizen client living in Europe, who is well aware of, and compliant with, his US tax and reporting obligations. John has set aside some funds, which he now desires to invest and grow in a tax efficient way, so as to transfer as much wealth as possible to his heirs. Ideally, these funds would be exposed to a broad spectrum of investments, both within and outside of the US.

However, so far, John’s advisor has limited his client’s investment universe to obviate the tax and reporting complexities which arise when US taxpayers hold assets that were not necessarily designed with the relevant US considerations in mind. For example, John has largely refrained from investing even in simple instruments that are otherwise commonly held by his advisor’s non-US connected clients, such as non-US mutual funds (which may be treated as PFICs – passive foreign investment companies – for US tax purposes), and European-issued life insurance (for fear that it may not qualify as such in the US).

Conversely, although John is familiar with wealth planning solutions that are common in the US, such as private placement deferred variable annuities, these solutions are often not designed to be held by taxpayers from John’s country of residence.

Such misalignments can be costly, for example, where a vehicle provides tax deferral in one country but not in the other. While this incongruence may occasionally be mitigated by tax crediting mechanisms, doing so is not always possible (e.g. where there are not sufficient excess credits available to the client).

Similarly, complex issues arise when advising trustees of foreign trusts with both US and non-US beneficiaries. For example, the trustee may be concerned about the trusts generating more income than is appropriate to distribute annually, which may trigger adverse US tax consequences when previously accumulated income is later distributed to the trust’s US beneficiaries under the so-called “throwback rules”. Other US tax and reporting issues may arise if the US beneficiaries are attributed ownership of the trust’s assets. Conversely, a solution that is efficient for the US beneficiaries may be of little value if it makes matters worse for the non-US beneficiaries.

Dual compliant solutions – the basics

Dual compliant insurance and annuity solutions can be simple and elegant tools to address the foregoing complexities that affect US connected high net worth individuals and their advisors. Generally, by their nature, such solutions would qualify as life insurance under the laws of the client’s country of residence, and either life insurance or an annuity for US purposes.

A wealth owner (or trustee) would subscribe to a dual compliant solution, whereupon the premium would be invested in an account held by the issuer, which in turn invests it according to a broad investment strategy selected by the subscriber. The value of the contract at any given point would depend entirely on the performance of the underlying assets.

Thus, the subscriber has enforceable contractual rights against the carrier (as per the contract, e.g. right to annuities, surrenders, death benefits) but no beneficial ownership of the underlying assets supporting the policy, which are owned by the contract issuer (though segregated from the carrier’s general account).

From a tax standpoint, a dual compliant policy’s primary benefit is income tax deferral in both the US and the other jurisdiction with which the contract is designed to comply. Tax efficient access during the accumulation period may be possible, depending on the type of policy and the jurisdictions at issue.

Effective dual compliant solutions must meet the necessary requirements to be treated as such in both the US and the other country in question. For example, local rules may impose strict requirements regarding the type of underlying assets supporting the policies (e.g. Italy and Belgium), or restrictions on the policyholder’s direction of the underlying investments (e.g. Germany), or a requirement that life insurance contracts qualify as such from inception by triggering adverse tax consequences when a contract is amended to achieve compliance (e.g. Spain). Similarly, to qualify for US tax deferral, an insurance contract must entail some degree of risk shifting, as delineated partly by the relevant statutes setting forth life cover parameters. Moreover, in the US, annuities must comply with specific payout timing requirements, among several other rules, such as the requirement that annuities be held only by natural persons or agents thereof. Lastly, some US requirements apply to all variable contracts, such as diversification requirements and limitations on policyholder influence over and foreknowledge of the composition of the policy’s underlying assets.

Dual compliant solutions – takeaways

An annuity or insurance solution that is compliant both in the US and in the client’s country of residence can accomplish the client’s goals by providing tax deferred growth, possibly tax efficient access and enhanced asset protection (depending on the policies and jurisdictions at issue). A dual compliant solution also affords simplified reporting (e.g. no K-1s relating to underlying investments), though reporting the policy itself may be required (e.g. on IRS Form 8938 and FinCEN 114, commonly referred to as FBAR).

Carefully designed and implemented dual compliant solutions may achieve similar goals for US and non-US beneficiaries of foreign nongrantor trusts, primarily by providing income tax deferral in both the US and other jurisdictions, thus serving as a viable alternative to trust domestication, or complex timing strategies and techniques often implemented upon the death of the settlor to mitigate the application of the throwback rules.

Today’s wealth advisors should not need to resort to a separate toolkit to service US connected clients. The ideal approach should seamlessly integrate US compliance so as to allow advisors to confidently prioritise the client’s way of life and succession plan, without sacrificing simplicity or compliance with non-US jurisdictions. To this end, dual compliant solutions can be a powerful ally to meet the needs and goals of clients with US connections, by integrating portable compliance to accommodate their increasingly mobile lifestyles.