What Is a Waterfall Concept?
The term “waterfall concept” refers to a popular estate planning strategy in which a whole-life insurance policy is transfered一or “rolled over”一from the policyholder to their child or grandchild.
Key Takeaways
- The waterfall concept is an estate planning strategy that uses whole-life insurance contracts to efficiently transfer wealth between generations.
- It can only be used to transfer wealth from an older generation to a younger one, such as in the case of a grandparent giving to their child or grandchild.
- In addition to their tax benefits, waterfall concepts can also help reduce probate issues and legal costs.
How Waterfall Concepts Work
The purpose of the waterfall concept is to ensure that wealth is passed on from one generation to another in as tax-efficient a manner as possible. It does so by structuring a tax-exempt whole-life insurance policy in a manner that permits its tax-deferred cash value to be withdrawn by the child or grandchild at a future date, after the original policyholder has died.
Whole-life policies have two components. In addition to the death benefit that pays out when the insured passes away, whole-life life insurance policies also accumulate a tax-deferred cash value as the insured pays premiums. Eventually, the insured individual transfers the life insurance policy to a descendant, at which point the funds become taxable on withdrawal.
In addition to its tax advantages, the waterfall concept can help avoid some of the pitfalls that can apply to gifts and other large-scale transfers of wealth. For example, waterfall concepts can be carried out using only the terms and conditions of the original insurance contract, without requiring the involvement of potential costly lawyers and intermediaries. Similarly, transferring wealth through a waterfall concept can help prevent those assets from being allocated to other parties as part of the probate process.
Real World Example of a Waterfall Concept
A typical example of the waterfall concept would be one in which the policy is transferred from a grandparent to a grandchild. The grandchild would then pay taxes only when withdrawing funds from the policy. To the extent that the grandchild’s tax rate is lower than that of their grandparent, this would result in tax savings overall.
When using the waterfall concept, it is important to structure the policy in a manner that protects against the risk that the original policyholder might die before the policy is transferred. One method to do so is by designating a third party, such as the child’s parent, as a contingent or irrevocable beneficiary, with the intention that the parent would then transfer the policy to the grandchild once he or she comes of age. This process could be entirely stipulated using the terms of the life insurance contract itself, without requiring the use of a trust or other such legal entity.
FAQs
The Waterfall methodology — also known as the Waterfall model — is a sequential development process that flows like a waterfall through all phases of a project (analysis, design, development, and testing, for example), with each phase completely wrapping up before the next phase begins.
What is a waterfall model with an example? ›
The waterfall model is a linear, sequential approach to the software development lifecycle (SDLC) that is popular in software engineering and product development. The waterfall model uses a logical progression of SDLC steps for a project, similar to the direction water flows over the edge of a cliff.
What is an example of a waterfall strategy? ›
Manufacturing: In manufacturing, teams use the Waterfall project management method to support different manufacturing and production phases and maximize efficiency. For example, an electronic device manufacturer may wait until the assemblers finish their work before preparing the project for packaging.
What is a waterfall example? ›
Manufacturing projects are another example of a waterfall project. These types of projects typically involve the production of physical goods, such as cars, appliances, or electronics. The phases of a manufacturing project typically include planning, design, procurement, production, and delivery.
What is the waterfall method of working? ›
What is waterfall project management? The waterfall project management approach entails a clearly defined sequence of execution with project phases that do not advance until a phase receives final approval. Once a phase is completed, it can be difficult and costly to revisit a previous stage.
What is a real life example of a waterfall model? ›
Real-world example: Imagine a construction project where a building is being constructed. In the Waterfall methodology, the project would progress in a sequential manner, with each phase being completed before moving on to the next.
Which is an example of a company that used waterfall methodology? ›
Well-known companies use the waterfall model in their software development process; one of these companies is Toyota.
What is a typical waterfall project? ›
The typical stages of Waterfall project management:
Requirements: The manager analyzes and gathers all the requirements and documentation for the project. System design: The manager designs the project's workflow model. Implementation: The system is put into practice, and your team begins the work.
What is a simple waterfall structure? ›
An example of a simple waterfall model may be a sponsor who offers an 8% preferred return and then a 70%/30% split. The sponsor here is telling investors that they should expect to receive their pro rata share of the distributable cash flow from a transaction until they have received an 8% return on their investment.
What is design in a waterfall model? ›
Design: The design phase of the waterfall process is best broken up into two subphases: logical design and physical design. The logical design subphase is when possible solutions are brainstormed and theorized.
Imagine a waterfall cascading down into a series of vertically-aligned buckets. The water represents money, and the buckets represent investors, partners, or stakeholders. The water fills the first bucket first. The second bucket will fill only after the first is completely full and spills over.
Where is waterfall model used? ›
The waterfall model is most commonly used in software engineering and product development, less often – in other projects and industries. Employ the waterfall model only if your project meets the following criteria: All the requirements are known, clear, and fixed. There are no ambiguous requirements.
What is an example of a waterfall investment? ›
Private Equity Waterfall Example
After the preferred return, the first tier splits the cash flows so the GP receives 20% and the LP receives 80%, but only until the LP receives an 8.00% IRR.
What is agile and waterfall with example? ›
Scrum, an Agile framework, emphasizes iterative development, team collaboration, and flexibility to change. Work is divided into sprints. Waterfall is a linear, sequential approach where each phase must be completed before proceeding to the next, making it less adaptable to change.
