March 5 quiz in Risk

In general, when are life insurance proceeds included in a decedent's gross estate?

-Decedent was the insured -Decedent owned a life insurance policy on the life of another -Decedent was the beneficiary of a life insurance policy

The federal estate tax is a ________________ imposed on the privilege of transferring assets at death. The amount of tax payable is measured by the ______________ of the assets transferred from the estate to the heirs. What this means is, while the estate tax is levied on the value of assets transferred, the estate tax _______________ be satisfied simply by transferring a percentage of estate assets to the IRS. Instead, your estate must pay the federal estate tax in __________, and it generally must pay it in _________ months! It may, however, be difficult, if not impossible, to liquidate sufficient non-liquid assets in order to pay the tax in cash. Estate administrative costs must generally be paid in cash as well.

-TRANSFER TAX -VALUE -CANNOT -CASH, NINE

A contract meets the definition of life insurance if an insurer must pay a specified ____________________ at the insured's death. 1. There must be an ___________________ present in order for the proceeds of the contract to be classified as life insurance at the insured's death. 2. If the terminal reserve value of the contract equals or exceeds the _______________ at the insured's death, the rules that apply to the estate taxation of annuities are applicable. (See Part 14)

-death benefit to a beneficiary 1. element of risk 2. face amount

Once the tentative federal estate or gift tax is determined, it is then reduced by an This means that _______________________________________________ will not be liable for federal estate tax.

-estate and gift tax unified credit -taxable estates with a value equal to or less than the unified credit equivalent. The same is true of cumulative lifetime taxable gifts which, however, will be brought back into the owner's estate for federal estate tax calculation purposes.

An irrevocable life insurance trust can be funded either by ______________________ of an existing life insurance policy to the trust, or by purchasing ______________:

-transferring ownership of an existing life insurance policy -purchasing a new life insurance policy

There are FOUR ways to provide your estate with the liquidity needed to meet its cash obligations.

1. 100% Method 2. 100% Plus Method 3. Forced Liquidation Method 4. Discount Method

There are certain payments made at an individual's death that are not considered life insurance for estate taxation purposes.

1. If payments are conditional or have an effect on other legal liabilities or rights connected with an individual's death, the payments are not considered life insurance for estate taxation purposes. ----This situation arises most frequently in connection with air travel and automobile policies. 2. Just because a payment is not classified as life insurance does not mean that it will not be subject to inclusion in the deceased's gross estate. It just means that it will not be included based on the estate taxation provisions dealing with life insurance.

An Irrevocable Life Insurance Trust in Action

1. The grantor makes an annual gift to the irrevocable life insurance trust sufficient to pay the premiums on the life insurance policy owned by the trust. 2. The trustee provides a notice to the trust beneficiary(ies) of the annual trust contributions subject to withdrawal, qualifying the gift for the annual gift tax exclusion. 3. Assuming the trust beneficiary(ies) do not exercise their withdrawal right, the trustee then uses the gift to pay the life insurance premiums. 4. When the grantor/insured dies, the life insurance death benefit passes income and estate tax free to the trust. 5. If needed for estate liquidity purposes, the trustee can loan money to the estate or purchase assets from the estate. 6. Finally, the trust assets are distributed to the trust beneficiary(ies) according to the terms of the trust document.

In addition to the death proceeds of a life insurance contract, the following are also considered life insurance for estate tax purposes:

1. accidental death benefits (regardless of whether payable from life insurance or a health insurance policy); 2. paid-up additional insurance; 3. proceeds paid from a policy rider at the insured's death 4. group insurance proceeds 5. death benefits paid by a fraternal society's lodge system 6. death benefit payable under "no-fault" automobile liability insurance (Rev. Rul. 83-44, 1983-1 CB 228).

At the grantors death tax implications

At the grantor's death: 1.Policy proceeds -- Free of income tax to the trust and to the trust beneficiaries when distributed a.Any earnings or proceeds retained by the trust, however, are taxed in the same manner as any other trust income b.If the policy was transferred for value to the trust, however, the proceeds may not be fully exempt from income tax .

In situations where the trust will need to make premium payments, a typical irrevocable life insurance trust arrangement calls for the grantor/insured to make annual gifts to the trust, which are then used to pay the life insurance premiums. In order for those gifts to qualify for the annual gift tax exclusion ($15,000 in 2020), the gifts must qualify as a "present interest gift." This can be accomplished by including a _____________ withdrawal power in the trust.

Crummy

100% Method You could accumulate enough cash in your estate to pay ___________________ outright. Rarely, however, does a successful person accumulate such large sums of cash. Instead, the reason for financial success is usually due to the investment of cash in appreciating assets, rather than accumulating it in a bank.

Estate settlement costs

Income tax liability is shifted from the grantor to the trust or trust beneficiaries, who may be in a lower tax bracket, unless the trust is treated as a grantor trust.

Funded Trust

Any trust income, losses, deductions or credits realized by the trust must be reported by the grantor if any of the following conditions exist:

Grantor Trust The grantor or grantor's spouse retains a reversionary interest that exceeds 5% of the value of the trust b.The grantor or grantor's spouse retains the power to control the beneficial enjoyment of the trust income or principal c.The grantor and/or trustee can revoke the trust d.The grantor or grantor's spouse retains certain administrative powers e.Trust income is or, in the discretion of the grantor or a non-adverse party, may be: (1)distributed to the grantor or grantor's spouse; (2)held or accumulated for future distribution to the grantor or grantor's spouse (3)used to pay premiums on a policy insuring the life of the grantor or grantor's spouse (4)used to discharge a legal obligation of the grantor or grantor's spouse

If the beneficiary dies before the insured:

If the beneficiary is simply the beneficiary of a life insurance policy and dies before the insured, there are no proceeds to include in the deceased beneficiary's estate.

If the beneficiary dies after the insured:

If the decedent had previously received a lump sum death benefit, any of those proceeds remaining at the decedent's death generally will be included in the deceased beneficiary's gross estate This is a very complex area. If a primary beneficiary is receiving death proceeds paid in installments under a settlement option, the commuted value of any remaining installments due generally is included in the deceased beneficiary's gross estate if: a .the commuted value is paid to the deceased beneficiary's estate b. the beneficiary had a general power of appointment over the proceeds, such as the right to revoke the contingent beneficiary designation or an unrestricted right to withdraw principal. c. Absent either of the above conditions, the transfer of any remaining installments from the primary beneficiary to the primary beneficiary at the primary beneficiary's death generally is considered a transfer from the insured. The commuted value of the remaining installments is not included in the deceased primary beneficiary's estate.

Transfer of existing policy: While an existing life insurance policy can be transferred to an irrevocable life insurance trust, there are "strings attached."

If the gift of an existing life insurance policy is made within three years of the grantor/insured's death, the value of the life insurance proceeds are brought back into the estate for federal estate tax purposes.

The uses of an irrevocable trust

If your estate is likely to face a federal estate tax liability, an irrevocable life insurance trust can replace funds used to pay the estate tax, without the death proceeds also being subject to the estate tax. If your heirs are likely to need additional estate liquidity after your death, such as to continue a family business, an irrevocable life insurance trust can provide that liquidity, again without the insurance proceeds being subject to the federal estate tax. If you want to control how death proceeds are distributed, you can do so through the provisions included in an irrevocable life insurance trust. If you have children from a prior marriage, but want your current spouse to be the primary beneficiary of your estate, naming your children the beneficiaries of an irrevocable life insurance trust can provide them with a distribution at your death, rather than at your surviving spouse's later death. If you want to leave your loved ones a substantial life insurance estate, an irrevocable life insurance trust can be used to pass the full value of life insurance proceeds to your heirs estate tax free. If you want to make a substantial bequest to a charity, either during your lifetime or at your death, an irrevocable life insurance trust can play a wealth replacement role, with the proceeds from the trust replacing for your heirs the value of assets given to charity.

What Are the Estate Growth Implications for a Married Couple?

In a properly arranged estate, the size of a married couple's estate at the death of the surviving spouse determines the estate taxes due.

What Are the Estate Growth Implications for a Single Person?

In the case of a single person, the size of the individual's estate at death determines the estate taxes due.

In addition to serving as a source of estate liquidity, life insurance provides a variety of other advantages:

Payment is prompt and certain. Life insurance proceeds are not subject to the time and expense of the probate process. The event creating the need for cash -- death -- also creates a source of cash -- the life insurance death benefit. The life insurance policy provides the dollars for a certain need -- estate settlement costs -- that arises at an uncertain time -- death. If the death benefit exceeds the total premiums paid, this gain generally is received free of income tax. For example, if only 20 cents of each death benefit dollar received has been paid in premiums, the 80-cent gain is received income tax free! The premium payments are spread out and not required in nine months. Life insurance avoids all of the problems associated with the other methods for paying estate settlement costs. By giving up ownership of the policy, the proceeds may be estate tax free. An attorney can provide you with the popular "Irrevocable Life Insurance Trust" for this purpose, or an adult child can be named as owner.

Gift tax implications

Policy -- The transfer of a life insurance policy to an irrevocable trust is a gift that is subject to the federal gift tax a.The value of the gift is the "fair market value" of the policy on the date of the gift: New policyPremiums paid Premium-paying policyInterpolated terminal reserve, plus any unearned premium and any accrued dividends, reduced by any outstanding policy loans Paid-up policyReplacement value (i.e., single premium the insurance company would charge for a comparable policy at the insured's attained age Group term life insuranceEmployee can elect to base gift tax value on annual Table I costs or actual cost of coverage. If the plan is discriminatory, key employees must use the actual cost of coverage. Insured in poor health or close to deathPolicy may be valued at or near face amount by IRS. 2.Premiums -- Any premiums paid by the grantor on a policy transferred to an irrevocable trust are taxable gifts, whether paid directly to the insurance company or through cash contributions to the trustee, who then pays the premium. a.Funded trust -- While any income-producing property transferred to an irrevocable trust constitutes a gift, trust income generated by that property and used to pay premiums does not constitute additional gifts. b.Trust beneficiary pays premiums -- The portion of the premium equal to the beneficiary's share of the trust does not constitute a gift because the payment is made to protect the beneficiary's interest in the trust. If there are multiple trust beneficiaries, any portion of the premium paid by one beneficiary that benefits other trust beneficiaries is considered a gift to the other beneficiaries. c.Someone other than grantor or trust beneficiary pays premiums -- Each premium paid by someone other than the grantor or a trust beneficiary is a gift to the trust beneficiaries.

Any trust income used to pay premiums on a policy insuring the grantor's life (or on the life of the grantor's spouse) are taxable income to the grantor unless the policy is irrevocably payable to a charity

Premiums in regards to a trust

Purchase of new policy: Assuming the grantor is insurable, it may be preferable to make cash gifts to the trust, which then purchases a new insurance policy on the grantor's life.

Since the grantor/insured never held any "incidents of ownership" in the new policy, the insurance proceeds should not be included in the taxable estate, even if death occurs within three years of the insurance purchase by the trust.

If you are considering use of an irrevocable life insurance trust, however, it is important that you also evaluate the potential drawbacks of this arrangement:

Since the trust is irrevocable, you relinquish control of the life insurance policy and annual gifts made to the trust. In addition, once the trust document is executed, you cannot change the terms or terminate the trust. If the trust contains the Crummey withdrawal provision in order to qualify the gifts to the trust for the annual gift tax exclusion, a beneficiary may exercise his or her right to demand a withdrawal. There is some expense involved. In addition to possible trustee fees, you should consult with an attorney experienced in estate planning in order to avoid unforeseen tax and distribution consequences.

100% Plus method Your estate could ____________ the cash needed to pay estate settlement costs. This, however, only defers the problem, since the money will then have to be repaid with interest.

borrow

If death occurs within three years of giving an existing life insurance policy to the trust, the value of the death proceeds will be brought back into the _______________________.

estate for federal estate tax purposes.

The _______________ _____________ ___________ is a transfer tax imposed on the privilege of transferring property at death

federal estate tax transfer property

the ________________ ________________ _____________ is imposed on the transfer of property during the property owner's lifetime.

federal gift tax transfer property

Death benefits are generally received free of ____________________.

federal income tax

Through a trust, one person (the _____________) transfers the legal title to property to another person (the ___________), who then manages the property in a specified manner for the benefit of a third person (the ________________).

grantor trustee trust beneficiary

While life insurance receives favorable _______________ treatment, there is no comparable special treatment afforded to the estate taxation of life insurance.

income tax treatment so basically to answer note card 24, no.

The unified credit equivalent is equal to $11,580,000 in 2020, as adjusted for inflation, meaning that an individual currently can transfer property valued up to $11,580,000, whether during life and/or at death, __________________.

incurring a tax liability

Naming the insured as trustee will cause the life insurance proceeds to be included in the _________________!

insured's taxable estate

The death benefit payable to the trust will not be included in the _____________________, assuming the insured held no incidents of ownership in the policy at death.

insured's taxable estate

If an existing life insurance policy is given to the trust, the value of the policy is subject to gift tax, but only if it exceeds the annual gift tax exclusion. The value of the policy is generally based on the policy's ________________________, a value that is usually close to the cash surrender value

interpolated terminal reserve value

an ______________________ can be used to remove life insurance proceeds from your taxable estate, so that your beneficiaries receive the entire amount undiminished by estate taxes

irrevocable life insurance trust

primary purpose of owning a life insurance policy in order to remove life insurance proceeds from the taxable estate and, as a result, avoid paying estate taxes on those proceeds.

irrevocable trust purpose

Regardless of your age, it is a fact that using __________________ is frequently the most economical method of providing needed estate liquidity.

life insurance

Discount Method Assuming you qualify, you can arrange now to pay your estate tax bill with _____________________. For every dollar your estate needs, you can give an insurance company from approximately one to seven cents a year, depending on your age and health. No matter how long you live, it is unlikely you will ever give the insurance company more than 100 cents on the dollar. In addition, the life insurance policy can frequently be structured to accommodate your unique premium payment requirements.

life insurance dollars

Forced Liquidation Method Your estate could _________________________ to pay estate settlement costs. Keep in mind, however, that a forced liquidation may bring only a small fraction of the true value of your assets if there is not a ready market. In addition, sales expenses are bound to be incurred.

liquidate sufficient assets

A trust can be a ___________ trust, which takes effect during the lifetime of the grantor, or it can be a __________________ trust, which is created by the will and does not become operative until death.

living testamentary

A Crummey withdrawal power gives the trust beneficiary a noncumulative, annual right to demand withdrawal from the trust. For the demand right to be legitimate, the trustee must provide the beneficiary with notice of annual trust contributions and provide an adequate amount of time, such as 30 days, for the demand right to be exercised. If the demand right is exercised, the trustee must deliver the funds to the beneficiary. If the demand right is not exercised, the annual gift is then available for the trustee to use for premium payment purposes. Since the beneficiary stands to ultimately benefit from the trust and since a demand withdrawal from the trust may affect the grantor's decision as to future gifts to the trust, beneficiaries generally understand that __________________

making a demand withdrawal is not in their best interest.

Since the estate tax is _______________, and administrative costs tend to grow with the size of the estate, it is important to consider the impact of the growth of your estate on the amount payable to your "unwanted heirs."

progressive

In addition, a trust can be a _____________ trust, meaning that the grantor retains the right to terminate the trust during lifetime and recover the trust assets, or it can be an _____________ trust, meaning that the grantor cannot change or terminate the trust or recover assets transferred to the trust.

revocable irrevocable

Specific examples of life insurance

see note cards 22 and 23

Does life insurance receive favorable estate tax treatment?

see note cards 25-26

What is considered life insurance for estate tax purposes?

see notecard 20

In addition, a __________________ can elect to take advantage of any unused portion of the estate tax unified credit of a deceased spouse. As a result, with this election and careful estate planning, married couples can effectively shield up to $23 million plus (as adjusted for inflation) from the federal estate and gift tax without use of marital deduction planning techniques

surviving spouse

When using a ______________, you may wish to retain ownership in order to use insurance cash values, if needed. The policy can be moved out of the estate by giving it away after the first spouse's death. If, however, death occurs within three years of the transfer, the proceeds will be included in the surviving spouse's estate.

survivorship policy

When an individual dies, _______________________________________, forms the gross estate, which is then subject to estate taxation. In the case of life insurance, "ownership" is rather broadly interpreted. For example, if the decedent held just a single "incident of ownership" (e.g., the right to change the beneficiary) within three years of death, the value of the life insurance asset is included in the decedent's gross estate. In addition, the value included depends on whether the decedent was the insured or the owner of a policy insuring someone else.

the property owned by the decedent

Annual gifts made to the trust for premium payment purposes must be subject to the Crummey withdrawal powers in order to qualify for the annual gift tax exclusion ($15,000 in 2020). Alternatively, gifts will be subject to the ____________________________

the unified federal gift and estate tax, but qulify for the lifetime exemption equivalent 11,580,000

a __________________ is a legal device for the management of property

trust

the legal rights of property ownership and control rest with the ___________, who then has the responsibility of managing the property as directed by the __________ in the trust document for the ultimate benefit of the _____________________.

trustee grantor trust beneficiary

The federal estate tax is a transfer tax imposed on the privilege of transferring property at death, while the federal gift tax is imposed on the transfer of property during the property owner's lifetime. Both taxes are levied on the right to transfer property, and not on the property itself. The amount of tax payable, however, is measured by the _________ of the transferred property.

value