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Top 10 Considerations for Estate Planning with Life Insurance

Top 10 Considerations for Estate Planning with Life Insurance

Some questions to discuss with your clients


If a life insurance policy is owned by a trust, what’s the ongoing maintenance required for the strategy to succeed most effectively?

Apply for a Tax ID (EIN) number from the Internal Revenue Service for the trust.

Set up a non-interest bearing checking account in the name of the trust. This account will be funded with cash to cover premium payments.

The grantor can assist the trustee with premium payments by making gifts to beneficiaries of the trust. These gifts can be deposited in the trust checking account. Such gifts must be within the guidelines for annual exclusion gifts (currently the exemption amount is $14K).

Crummey v. Commissionerin 1968: the 9thcircuit court decided in favor of Crummey, stating that if a trust allows beneficiaries to withdraw the annual exclusion gift made, it falls within guidelines of the Internal Revenue Code. Such freedom to withdraw gives the beneficiary a present interest. This present interest is grounds for transfers to qualify for the annual gift exemption.

For each gift made to the trust, a letter called a “Crummey Notice” must be sent to each beneficiary alerting them of the gift and their right to withdraw for up to 45 days.


What are Cristofani beneficiaries and how can they make a life insurance trust even more gift tax efficient?

Taxpayers pushed the limits further when the estate of Maria Cristofani challenged the IRS’ decision to not allow “Crummey gifts” made to contingent remainder beneficiaries.

The 9thCircuit Court ruled that, according to IRC 2503(b), trust beneficiaries, including minors, having unrestricted rights to demand immediate withdrawal, have a present interest in the gift. Again, this withdrawal right establishes the present interest that supports the validity of the transfer.

This ruling is particularly useful if the grantor prefers to apply annual exclusion gifts to others, which will allow him to make separate annual exclusion gifts to his children. It’salso helpful in cases where policy premiums are significant in order to avoid gift tax.


How can insurance be used to facilitate a business succession plan? 

When transferring a family or closely-held business, there’s a possibility that not all of the children will be interested in or suited to take ownership of the business. In fact, it’s possible that none of the children will want anything to do with it.

If the business is one of the largest assets of the estate, it may present difficulty when attempting to equitably divide assets to beneficiaries. A life insurance policy can provide cash to even out distributions.

For businesses that have significant cash flow needs, or for clients with substantial real estate holdings that function as a business, a life insurance policy can guarantee liquidity to cover maintenance expenses–a worry no one wishes on grieving loved ones.

Insurance is an essential component of businesses with multiple partners and buy/sell agreements to ensure that the surviving partners have liquidity to buy out the interest of the family of a deceased partner.


Term, whole life, 2nd to die–from a layman's standpoint, what are the unique benefits of each?

Second-to-die (Survivorship) life insurance is a form of whole life insurance that covers two lives and pays the proceeds at the death of the second insured. Potentially, there could be lower premiums since it is unlikely that the insurance company will have to pay out too early. It’s important to consider the amount of the annual premiums because, after the first death, the annual exclusion gifts may no longer be split between the married couple.

Term is life insurance that provides coverage at a fixed rate of payment for a limited period of time. After that period expires, coverage at the previous rate of premiums is no longer guaranteed. If the insured dies during the term, the death benefit will be paid to the beneficiaries.

Whole life insurance is a policy that remains in force for the insured's whole life and requires premiums to be paid every year into the policy. 


How can ownership and beneficiary designations for a life insurance policy affect the taxable assets of the estate?

Given the unlimited marital deduction, it’s most typical that proceeds from a life insurance policy move tax free to the surviving spouse. This occurs in one of three ways: (1) Directly, naming the spouse as beneficiary of the policy, (2) In a tax-efficient/asset-protected trust for the benefit of the spouse created under the will, or (3) through the use of a Life Insurance Trust.

If the beneficiary is not the spouse, there are multiple beneficiaries or the policy is a second-to-die policy, the proceeds from the policy are taxable over the state estate tax exemption amount.

One caution: If individuals are named directly as beneficiaries, the estate has no legal right to know the beneficiaries or percent allocations to each. Often, insurance companies will let the executor know, but we’ve had experiences where insurance companies refused to share such information necessary for filing estate taxes.


How do non-citizens avoid qualified domestic trust (QDOT) requirements with a life insurance trust?

A life insurance trust, if it successfully removes policies from the insured taxable estate, will not subject a non-citizen surviving spouse to QDOT requirements because the policy proceeds pass estate-tax-free to the survivor through the trust, and there’s no need to leverage the unlimited marital deduction.

If a trust is created to own the policy, we only include QDOT language in the unlikely event that it becomes necessary to take advantage of the unlimited marital deduction because the insured did not survive the three-year look-back period or if the insurance was purchased directly by the trust.

If you are British, any trust–even a revocable trust–is deemed to be a gift and is subject to tax on the creation of the trust.


What are some strategies to avoid the three-year look-back period when existing insurance is transferred to a trust?

If a policy is already owned and the insured chooses to place the policy into a trust, he can choose to make a lifetime gift to the trust, which can then purchase the policy for the interpolated reserve value of the policy.

If a trust is created for the policy in advance of or concomitantly with the purchase of the policy, the trust can be the original owner and beneficiary of the trust.


Annual exemption gifts can fund a life insurance trust gift tax-free, but what about generation-skipping transfer (GST) tax issues? How is the trust affected?

The IRS will automatically allocate GST tax exemption to any annual exclusion gifts made to the trust if no gift tax return is filed.

In order to preserve your GST tax exemption for larger lifetime transfers that may experience significant growth off of your balance sheet, we recommend that you file gift tax returns for your annual exclusion gifts in trust. No tax will be due, but you’ll be afforded the opportunity to effectively control allocation of your GST tax exemption to maximize tax-efficient wealth transfers to grandchildren and generations beyond.


When the terms of an irrevocable trust don’t reflect the wishes of the parties, what options are available?

There are times when new beneficiaries or an evolution of relational structures, financial situations or other factors effectively change the game with regards to your estate plan. The life insurance trust is irrevocable, but we may have the opportunity to decant the old trust.

Decanting laws vary from state to state. Decanting techniques can pass the assets into a new trust and take advantage of enhancements that may have emerged in the trust code since the original trust was created.

Establishing a new trust for your life insurance is another potential method. This new trust must be funded with assets valued equal to the purchase price of the policy, namely the interpolated reserve value. A transaction between the trustees of the old and new trusts will be needed. A signed contract of sale allows the policy to be purchased by the new trust in exchange for assets/cash to the old trust. The trustee of the old trust can then choose what he would like to do with the assets in that trust, including making a full principal distribution.


How can life insurance be used as a wealth replacement strategy with charitable giving?

As wealth replacement for sale of a business, a client could gift shares of a company to a charitable remainder unitrust (CRUT). Inside the tax-free vehicle of the CRUT, the trustee sells the company free of capital gains tax. Then, using distributions from the trust, the grantor can purchase a life insurance policy equal to the cash value of the company, effectively replacing the gift.

A further suggestion here would be that the grantor establish a private foundation to be the recipient of the remainder interest of the CRUT. This way, the grantor can effectively bring his family into the philanthropic decisions for years to come and establish a legacy of giving.

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