Ch 22: The Role of Life insurance in Estate Planning

term life insurance

Term life insurance provides coverage for a finite period of time expressed as a number of years such as one, 5, or 10

The GSTT applies to trusts in two circumstances

—taxable distributions and taxable terminations. A taxable distribution occurs if a distribution of trust income or principal is made to a skip (with respect to the grantor of the trust) beneficiary .

possession of incidents of ownership

A policy is also included in an insured's estate if he or she possessed an "incident of ownership" in the policy at the time of his or her death The regulations provide that incidents of ownership include (but are not limited to) the power to

gifts of life insurance

An outright, no-strings-attached gift of life insurance qualifies for the annual exclusion.

IRS position in Crummey case

Because three of the beneficiaries of the trusts that Crummey had created were minors, the IRS asserted that a present-interest gift was not possible Because the minors in the Crummey case could not own the gifted property or even "own" the benefits created under the terms of the trust, according to the IRS, present-interest gifts were impossible

The Crummey Case

Clifford Crummey, created four irrevocable living trusts for the benefit of his four children, aged 22, 20, 15, and 11. Because the transfer of property into the trusts qualified as a taxable gift, the taxpayer took the annual exclusion (at that time, $3,000 per donee) for each child. The IRS, however, stepped in and disallowed the annual exclusion for those beneficiaries under the age of 21.

gross estate inclusion for policies on life of decedent

If a life insurance policy must be included in the decedent-insured's gross estate for federal estate tax purposes, the amount included is the death benefit of the policy death benefit of face amount is adjusted by (1) deducting any policy loan, or other encumbrance and (2) adding any accrued or terminal dividends

Generation-Skipping Transfer Taxation of Life Insurance

If life insurance proceeds are payable directly to, or may someday benefit, skip persons, the proceeds might be subject to the GSTT

gifts of life insurance to trusts

If the grantor transfers a life insurance policy to a trust, the present-interest rules apply—not the future-interest rules discussed above. t. Therefore, if the annual exclusion applies, most irrevocable life insurance trusts will not incur gift tax liability Fortunately, it is possible to design an irrevocable life insurance trust that qualifies as a present-interest gift for annual-exclusion purposes

nonemployed spouse insurance

If the nonworking spouse is no longer living, someone must be paid for household and parenting services he or she previously rendered if a nonworking spouse dies, a joint return for federal income tax purposes is no longer available to the survivor. The additional amount of income tax can be substantial over a period of years

joint life insurance

Joint life insurance (also called first-to-die insurance) covers the joint lives of multiple insureds and provides its death benefit at the first death of the joint insureds. Joint life insurance is often used in buy-sell agreements in which the first death of two or more co-owners of the business will create the need to fund the purchase price required under the buy-sell agreement

proceeds payable to estate

Life insurance proceeds payable to the executor (that is, to or for the benefit of an insured's estate) are includible in the estate, regardless of who owned the contract or who paid the premiums. There are many reasons in addition to avoiding federal estate taxation why estate planners seldom recommend that life insurance be payable to a decedent's estate:

life insurance and marital deduction

Life insurance proceeds that are payable at the insured's death to the insured's surviving spouse can qualify for the federal estate tax marital deduction if the requirements for the deduction are me qualification for marital deduction, complicated if spouse does not receive outright; deduction may not be available without these provisions, the trust can qualify only if the decedent-spouse's executor makes the QTIP election.

federal gift taxation of life insurance

The annual exclusion (or twice the annual exclusion amount if gift splitting) of gifted value per year per donee may be excluded from the gift-tax base when life insurance is gifted each premium is gift With proper trust drafting, Crummey withdrawal powers are used to create a present interest for annual exclusion purposes.

avoiding estate inclusion (Headrick case)

e IRS indicated that it will no longer litigate the Sec. 2035 3-year-rule implications of life insurance policies newly acquired by an ILIT. Thus a client will be within a safe harbor if an ILIT is created and administered according to the facts of the Headrick case

gross estate inclusion for policies owned by decedent on lives of others

the policy is included in the decedent's gross estate at its fair market value at the time of the decedent's death. insurance company's comparable contracts, which is typically the single-premium cost of a similar policy on the life of a person at the insured's attained age if no ascertainable value, the value is equal to the policy's interpolated terminal reserve at the date of the decedent's death plus the proportionate part of the unearned premium

permanent life insurance

Permanent insurance is coverage that is designed to exist for the entire life of an insured. A distinguishing characteristic of permanent insurance is the existence of a cash value or accumulation buildup within the policy. Permanent coverage can be designed either on a fixed-price premium or flexible-premium basis.

irrevocable life insurance trust (ILIT)

Placing ownership of a policy with an ILIT aims to make the trustee the effective owner of a policy that will fund the trust upon the death of the insured practical control in individual's hand not included in gross estate must ensure that it is drafted properly cannot be revoked insured relinquishes control over policy can be designed to bypass both spouse's estate; surviving spouses could be given life estate with limited invasion power; 5 and 5 powers ; A properly designed trust can also be the owner of a second-to-die policy that covers the spouses, and the second-death benefits avoid inclusion in either spouse's estate

planning w/ life insurance

essential component for wealthy favorable tax rules Life insurance goals in general can be divided into two categories: estate enhancement, and estate liquidity

estate liquidity

older clients or clients with large estates If older estate owners have accumulated enough wealth and/or have an adequate retirement plan, the need for estate enhancement from life insurance is diminished in importance relative to their estate liquidity needs life insurance is appropriate for liquidity concerns when federal, state, and generation-skipping transfer taxes are significant and also when estates contain illiquid assets such as closely held businesse

application of Crummey power to ILITs

possible federal gift tax created: (1) by transferring existing life insurance policies into a trust, and/or (2) by gifting premiums to the trustee, the availability of the annual exclusion becomes very important because it is a method to reduce or even eliminate federal gift tax liability

ILITs and Sec. 2035 3-Year Rule for Existing Policies Owned by Insured

the proceeds will be included in the insured's gross estate if the insured's death occurs within 3 years of the policy's gratuitous transfer to a third party To achieve estate tax advantages, a grantor-insured will have to survive more than 3 years following the transfer of his or her life insurance policy to an ILIT transfer is still a useful planning technique since the full amount of policy proceeds will avoid estate taxation if the grantor-insured survives the 3-year period

gift tax

third consideration A lifetime transfer of a life insurance policy will likely be considered a taxable transfer if the value of the policy exceeds the annual exclusion amount (currently $15,000, as of 2019)

transfers within 3 years of death

under the unique rules of Sec. 2035, life insurance is included in the gross estate of an insured who transferred incidents of ownership in the policy by gift within 3 years of his or her death

avoid crummey powers for special needs beneficiaries

Although it is generally considered important to shelter gifts to an irrevocable trust by the use of the federal gift tax annual exclusion, the provision of a Crummey power for a special-needs beneficiary should be avoided. A Crummey power is a general power of appointment and the beneficiary provided with this right must have no legal impediments that would prevent the withdrawal of any funds subject to the power may need 3rd party supplemental neesd trust

ILIT Terms Should Avoid Directly Benefiting Insured's Estate

If the trustee is directed to pay the expenses of the estate, the IRS will deem the policy payable to the executor, and the proceeds will be included in the insured's estate should not cause the proceeds to be treated as "payable to the executor"

Grandparent- Grandchild Trust

grandparent to purchase insurance on the life of a child for the benefit of his or her grandchildren trustee also pays premiums and designates the trust as beneficiary

present- interest dilemma

Sec. 2503 state that the annual exclusion is available only for gifts of a present interest A problem arises in creating a present interest when a gift is made to a trust for the benefit of the donee-beneficiaries. ILIT is future interest trust Can irrevocable trusts that defer beneficiaries' receipt of benefits be designed to qualify as present-interest gifts sheltered by the annual exclusion? The answer is yes, through the granting of Crummey withdrawal powers

survivor ship life insurance

Survivorship life insurance (also called second-to-die or last-to-die insurance) is a permanent life insurance policy that provides coverage on the lives of two individuals. The death benefit under the survivorship policy is payable upon the death of the survivor of the two insureds. married couple

holding of court in crummey case

The court in Crummey rejected the IRS's position and held that a present-interest gift had been made because the guardian named by the taxpayer in the trust had been given the power to demand distribution on behalf of the minors annual exclusions available for premiums given to an ILIT as long as ILIT contains language that requires trustee to notify beneficiaries that payments to cover premiums have been transferred to the trust and beneficiaries have right to demand distribution of payments

Crummey withdrawal powers

With an ILIT this is accomplished by giving each donee who will receive annual-exclusion gifts the right to receive the gift outright immediately The goal is to give the beneficiary access to the money but to inform the beneficiary when you set up the trust to not take the premiums so it can fund the policy or trust

revocable life insurance trust (RLIT)

advantageous because it can provide asset management and dispositive flexibility revocable trust works extremely well in cases where estate-tax planning is not the life insurance plan's primary concern young couple with minor children might find a revocable trust to be helpful when the primary need for life insurance is estate enhancement RLIT in conjunction with the grantor's will that contains a pour-over provision; the death proceeds are paid to the trust For some estate owners, the advantages of flexibility and control of an RLIT outweigh the disadvantage of inclusion of the life insurance in the gross estate.

estate enhancement

clients have estate enhancement as the primary goal for their life insurance coverage because they are either too young or have otherwise failed to accumulate sufficient wealth to provide for their heirs in the event of their passing

removal of life insurance from insured's gross estate- two ways

cross-ownership between spouses—a criss-cross method wherein one spouse owns the life insurance on the other spouse's life and that spouse owns the life insurance on the opposite spouse's life irrevocable life insurance trust—a trust created for the express purpose of holding the life insurance policies involved

advantages of annual exclusion

d to prevent taxation of de minimis gifts to family members through the gift tax system Taxable gifts (gifts in excess of the annual exclusions and marital deduction) are, on the other hand, returned to the donor's estate tax base as adjusted taxable gifts, even if the taxable gifts were fully sheltered by the applicable credit amount

advantages of ILITs

gift tax advantages ($15k per donee; $30k for married, $11.4m shelter) Generation skipping transfer tax advantages (benefit for grandchildren; can avoid any GST consequences by allocating his or her GST exemption against premium gifts to the ILIT) probate expenses and publicity avoided trust terms give grantor dispositive flexibility (directs trustee to manage trust according to term; can be given powers to sprinkle income or principal) irrevocability concerns can be addressed (independent trustee can transfer policy from ILIT; independent judgement)

cross ownership

if new life being purchased on one's spouse life, other spouse should act as owner and applicant no transfer of life insurance and no sec 2035 3 year rule problem if insured already owns policy, ownership should be assigned to spouse problems: divorce, unpredictability of order of spouse's death