When individual dies there are three ways property may pass:
1. Contract designation.
2. By law.
3. By Will.
Probably the best examples of property passing by contract are life insurance, annuity contracts and trust agreements. The benefits of owning a life insurance policy are numerous but for estate planning purposes the critical benefit is the right the individual has in naming his/her own beneficiary. By naming a beneficiary the owner obligates the insurance company to pay the proceeds to the designated beneficiary. If the policy owner named a beneficiary for the policy in his/her Will, this would have no effect if the beneficiary designation in the policy were different. One consideration that is usually not conducive to proper estate planning is to name the estate of the insured as the beneficiary as the proceeds will now be tied up in the probating of the estate and thus subject to possible long delays.
Trust agreements are another example of transfer by contract.
The following IRS Code Sections apply as indicated:
Five annuities are includible in a gross estate:
F Key Factor: Basically, if the beneficiary receives any benefits under an annuity or annuity-like arrangement, these payments are included in the gross estate.
Creation of a joint interest in property between spouses is no longer considered a gift. Present-interest gifts between spouses qualify for the unlimited gift tax marital deduction.
FNote: If property was acquired by gift/bequest/inheritance by a non-spouse joint owner, only the value of the fractional interest of the first tenant to die enters the gross estate.
Life insurance proceeds do not qualify for the marital deduction if the life insurance is payable to a surviving spouse but is not in decedents’ gross estate (any incidents of ownership).
Ralph is employed by Sandler Co. and participates in a pension plan that is entirely paid for by Sandler Co. The pension plan has a death benefit that would pay $50,000 at his death, to his beneficiary, his wife. If Ralph dies and his wife elects to receive the $50,000 in a lump sum, she would have to pay income tax on the proceeds.
Transfers of Life Insurance within three years of death are included in gross estate as gratuitous transfer inclusions of gross income are quite extensive.
One of the potential expenses of settling an estate is the federal estate tax. It is a continuous lien on property, but its foreclosure date has yet to be determined. Proper planning involves anticipating and reducing the estate tax liability wherever possible as well as providing for the payment of the estate tax. Unlike other expenses of settling an estate, it can be quite burdensome in that it is generally due and payable in cash nine months after death.
The estate tax computation is not difficult, and in many ways resembles the calculations involved in determining the income tax. Terms such as gross income, taxable income, deduction and credits are seen and are familiar because of federal income tax filing. The estate tax computation involves the same terms.
SEVEN CRITICAL POINTS
Primarily, there are seven points to remember involving the calculation of the federal estate tax:
The Adjusted gross estate is equal to the gross estate less:
Amounts that actually were spent for such expenses. These expenses would include such costs for tombstone, monument, mortician service, burial plot, transporting the body, etc. The key factor is if the costs are "reasonable" and are allowed as a charge against the estate under state law.
Administrative expenses are those concerning the estate which could include court costs, Executor's commission, attorney's fees, accounting fees, miscellaneous costs to properly settle the estate and medical expenses of decedent's last illness (this could be included as income tax deduction instead). The major requirement for deductibility is that the expense must be necessary, essential, actually incurred, and reasonable with respect to settling the estate.
Are any bona fide debts incurred by the decedent before death and are certain taxes deductible from gross estate? Deductible taxes would include the federal income taxes and also the state local, foreign income taxes and property taxes (these could also be deducted on the federal income tax return but not on both), also real estate taxes and local, foreign income taxes on estate income.
Mortgage debts will be allowable as deductible estate tax expenses if the full value of the property not reduced by the mortgage is included in the gross estate and if the estate is liable for the mortgage debt.
Casualty and theft losses may not be claimed if compensated by insurance and may not be claimed on both state tax and estate income tax forms.
Included in this category are funds used to settle non-Probate assets (life insurance and jointly held property).
Note: There are two basic decisions the Executor must make when claiming the various expenses for estate tax purposes.
Once these expenses have been calculated, one has arrived at the adjusted gross estate.
In the past the community property states only called for one-half of the community held property to be included in the estate of the spouse who died first. Residents of the common law states were envious of this preferential tax treatment so Congress gave a federal estate tax marital deduction to married residents in the common law states. The Economic Recovery Tax Act achieved tax parity by allowing an unlimited deduction for assets passing from one spouse to another, either during lifetime or at death. The Unlimited Marital Deduction applies in both Community and common law states. Please remember that the marital deduction is not a device to avoid taxation but defers taxation until the death of the second spouse. Congress's goal was to treat spouses as one unit for transfer tax purpose and only tax one estate. Presumably, without proper planning, the second estate will be much larger than the first estate thus rendering more estate taxes.
As may be expected there are numerous roles that govern the use of the marital deduction, with some exceptions. The seven basic rules are:
The state tax marital deduction is given on the full net value of a qualifying interest passing to a decedent's surviving spouse but will be reduced by any taxes that are payable out of the marital share of the estate.
Is the gross estate tax value of property interest at date of death (or at alternate - valuation date) less any charges against the property interest.
Three charges against property interest could be:
FSpecial Note: These charges can be avoided if the decedent's Will requires taxes/expenses debts to be paid out of the portion of the estate passing to beneficiaries other than the spouse.
Property must pass or have passed to the surviving spouse. A property interest owned by the decedent must pass from decedent to the surviving spouse and the surviving spouse must receive that interest as the beneficial owner (not as a trustee or as someone's agent). Property may "pass" from the decedent to the surviving spouse in many different ways, and still qualify for the marital deduction. Some of these ways are:
FNote: To qualify for the Marital Deduction the property that passes to the spouse cannot be a "Terminable Interest.” This is a property interest that will fail to terminate because of the passage of a time period and the occurrence of some event or contingency or because of failure of an event or contingency to occur. (See next page)
The deceased spouse must have been a citizen or resident of the United States to qualify for the Marital Deduction and transfer must be made by a decedent who was at the date of death a U. S. citizen/resident. In general, a marital deduction is not available if the surviving spouse is not a U.S. citizen unless property passes to the surviving spouse in a qualified domestic trust.
To be eligible for the marital deduction, the property must meet all requirements for being included in the gross estate.
Shelby purchased a $500,000 life insurance single premium policy on her husband, Cecil, when she received an inheritance from her aunt. If Cecil should die and Shelby would receive the face value of the policy ($500,000), the proceeds of life insurance policy bought by a wife on her husband's life with her own funds in which she is owner and beneficiary will not qualify.
Spouses must be married, not divorced. A legal separation or decree of divorce does not change the surviving spouse's status (the marriage was not legally terminated by the date of death).
In case of a common disaster there are two methods of determining who died first (who was the surviving spouse):
1. A presumption-of-survivorship clause may be used in the Will/life insurance settlement option (e.g., husband declares that if there is no evidence to determine who died first, "my wife shall be deemed to have survived me").
2. Uniform Simultaneous Death Act which states if there is no presumption-of-survivorship clause, each decedent's estate will be distributed as if decedent were the survivor (husband's Will is Probated as if he survives his wife and wife's Will is Probated as if she survives her husband). This results in the loss of marital deduction.
A marital deduction is allowed only when the interest passed to the surviving spouse is one that, if kept until that spouse's death, will be taxed to the surviving spouse's estate. (See previous page)
A terminable interest may be disqualified if all three of the following conditions exist:
FNote: If the decedent in the Will directs the Executor to use assets supposedly available to the surviving spouse for the purpose of terminable interest, then the marital deduction would not apply.
If Bill specifically bequeaths $150,000 to his wife but since Bill had little faith in his wife’s ability to manage money, he directed his Executor to use that money to buy a life annuity for her. By doing so, however, the bequest will not qualify for the marital deduction.
FSpecial note: To avoid any problems under the terminable interest classification, the property must be vested in the surviving spouse and no other person may have any interest which may follow that of the spouse's.
Exceptions to the Terminable Interest Rule
This is the most common method of qualifying property in trust for the marital deduction. The Power of Appointment Trust is designed to hold assets for the surviving spouse and to provide that spouse with a General Power of Appointment over the principal. Five requirements are needed to qualify.
Final exception to the terminable interest rule: an interest will still qualify for the marital deduction if the bequest to the surviving spouse was conditioned upon the spouse surviving for up to six months after the decedent's death and spouse does survive.
There are seven reasons( at least) why life insurance should be included in estate planning:
CONSUMER APPLICATION
The following is an example from the files of a Financial planner, who recognized it as the poorest example of “Estate Planning” he had ever seen!
Maribell is an heir to a large fortune and has an assessed net worth of over $25 million. She informed her financial planner that the I.R.S. would probably say that the estate was worth double that amount. However, she had purchased sufficient life insurance so that her children would have enough money and the government would not get all of her money.
Unfortunately, she informed the Planner that she had instructed the children to keep the insurance money and let the government have the property.
Upon her death her property was worth $40 million. Her life insurance policies paid $20 million to her heirs outside of the taxable estate. Her children did as she asked and took the $20 million, and gave the rest to the I.R.S. to satisfy the taxes.
The I.R.S., as is its practice, auctioned off the property to the highest bidder, and received only $10 million from the property. Her heirs are responsible for the other $10 million.
(Note: Under the 2001 tax act, eventually this estate tax will disappear. Good riddance.)
Properly designated life insurance will do wonders for an estate plan. It will enable the Executor to sell any property or business interests in a timely fashion and prevent forced sales. It will save the burden of a long settlement period and reduce the overall shrinkage of an estate. Life insurance will provide two clear advantages.
1. It will provide cash for the decedent's estate when needed the most.
2. It will provide a way to retain the full value of assets in an estate.
The important aspect of life insurance is: Who is the owner and who will receive the proceeds (beneficiary)? There are five rules to follow when the planner is advising the client as to the owner-beneficiary designations:
The planner should present different situations when discussing the ownership question with clients. There is no defined rule. Every client is different and each client's objectives will vary also. The planner’s responsibility is to listen to the client's concerns and then make recommendations. All decisions should be based on the facts surrounding each particular situation. In every situation, it is important that the planner understand the ramifications of each in order to advise a client as to the advantages/disadvantages of the client's specific objections.
The primary question will be "who should handle the proceeds at the client's death?” Putting such proceeds into the hands of someone who is trustworthy and competent will go a long way to having liquidity achieved in the estate.
Basically there are three designations seen during the course of estate planning. The impact of gifting life insurance and the assignment of a group life policy will also be discussed.
Small Estates. In a small estate, naming the estate as beneficiary should not have any potential tax problems at death, particularly in view of the increasing amount of an estate exempt from estate taxes. If a married couple is involved, the unlimited marital deduction will further help reduce or negate entirely the estate tax consequences.
Larger Estates. By naming the estate as beneficiary could have severe repercussions - just the opposite of the intended objective. By including the proceeds in the deceased's estate, more taxes would be paid and thus subject to Probate and to the claims of creditors. Thus, instead of reducing costs, life insurance, in this instance, could result in increased costs and liabilities.
Usually in this situation a spouse is named as the beneficiary. This arrangement does have some advantages and, of course, some disadvantages.
Proceeds would avoid Probate and usually are not subject to the claims of creditors. Many states exempt death proceeds payable to a surviving spouse from the state death tax. Consideration must be made before using this designation would be:
Disadvantages:
When the spouse is named, it is assumed that the proceeds will be used for their intended purpose, estate liquidity. However, the spouse is not legally obligated to use the proceeds in this way. The spouse could have other ideas on how to use the proceeds thus eliminating the primary purpose of the proceeds. The one way to prevent this situation is to have the policy require the spouse to use the proceeds for the estate's liquidity needs, and the proceeds will be considered "payable for the benefit of the estate.”
Usually seen in larger estates a trustee arrangement offers distinct advantages. The trustee will carry out the purpose of the policy - providing liquidity for the estate.
The trust agreement will authorize the trustee to make loans to the estate and to purchase assets from the estate if the need arises. The Will of the insured should stipulate the relationship of the trustee and Executor.
The trust probably would be established during a lifetime. If the trust is irrevocable and owns the policy then the proceeds will escape inclusion in the insured's estate. The disadvantage to the insured is that there are fees involved.
Each life insurance policy has three “offices”: The insured, the owner and the beneficiary. Generally, but not always, the owner and the insured are the same. If life insurance is owned by the decedent, the life insurance proceeds are in the taxable estate, therefore a tax may be due.
FWhen people who have a large taxable estate, purchase life insurance to pay the tax, they often make the mistake of adding to their taxable estate by the purchase of life insurance.
CONSUMER APPLICATION
Victor is widowed and has an estate valued at $10,000,000. Because he knows that the federal estate taxes could equal at least half of his estate, he purchases a $5,000,000 life insurance policy.
If Victor takes ownership of the policy (i.e. he is both insured and owner), his taxable estate has grown to $15,000,000 – with a resultant tax of $8,000,000 (1999 figures).
But, if he creates a life insurance trust, gives the trust money, and lets the trust buy the life insurance policy, the trust is the owner, with the result now that substantial amounts of federal estate tax are saved.
Why? Because the Trust is the owner, and the owner, therefore, does not die.
Most clients will want to use their group life proceeds to create estate liquidity. The courts have allowed clients to absolutely assign all ownership rights to the group ownership out of their estates. This helps the estate as the proceeds are excluded from the insured's gross estate thus preventing more estate taxes!
F Note: An employee will be taxed on the cost of coverage in excess of $50,000 as provided in IRS regulation under Section 79. Absolute assignment does not help in this situation.
A life insurance policy is included in the insured's estate for federal estate taxation purposes if the insured had an incident of ownership in the policy at the time of the insured's death. Incidents of ownership include the following:
1. The right to change the beneficiary.
2. The right to borrow on the policy.
3. The right to assign the policy.
4. The right to surrender the policy.
5. The right to exercise any basic contractual right.
If the deceased possessed any of the above rights, the proceeds will be includible in the deceased gross estate. It does not matter whether the incidents were ever exercised or not!
In respect to life insurance transferred to a third party within three years of an insured's death, the general rule is that the transfer is automatically includible in the insured's estate.
If an individual owns a policy on the life of someone else and if the owner dies before the insured, the value of the policy must be included in the owner's gross estate. The value of such a policy is the replacement cost.
Proceeds would be included in the gross estate if the policy proceeds on the life of the deceased are paid to or used by the Executor or the Administrator of the estate. If the estate or the estate's Executor is the designated beneficiary of the proceeds, the proceeds are included in the deceased's gross estate, regardless of when the policy was taken out, or who paid the premiums, or who owned it.
If the proceeds are paid to an individual or a trust that is legally obligated to pay taxes, debts or other estate obligations, the proceeds will also be included. At times the trustee of a living trust is only empowered to use trust assets to pay estate obligations not required to do so. In this situation, death proceeds of life insurance paid into the trust would only be included in the gross estate to the extent the trustee exercised the power to pay estate obligations. (See discussions of ILIT later in this text)
In most states, any proceeds payable to - or - for the benefit of the insured’s estate is included in the decedent's estate. Proceeds payable to the surviving spouse are never part of the taxable estate due to the unlimited marital deduction. Four qualifications for the marital deduction are:
1. Lump sum proceeds are paid to the surviving spouse.
2. Non-refundable life income payments made to the spouse;
3. Settlement option used to hold proceeds for surviving spouse;
4. Surviving spouse has a general power of appointment.
Any person, whose motivation in purchasing life insurance is to protect the estate, should first plan that estate to reduce or avoid every cost possible. After the projected costs have been reduced to the lowest dollar possible, life insurance should then be purchased to cover the remaining costs. The estate planning process creates the car, gas tank, and gasoline gauge. While the life insurance is the gasoline, in the right amount and in the right octane, the amount and type of life insurance must meet the designer's specifications.
Prudent estate owners should always plan to pay their estates debts with cash. If Estate property is to be sold then it should be sold at the highest possible price and should not be time constrained. Life insurance should be used to create instant estate cash. The more non-liquid the estate, the greater the potential need for life insurance.
In summary there are twelve key points to consider when discussing life insurance in the estate plan:
Under the Economic Recovery Tax Act, people can leave their entire estate tax free to their spouses and can leave all or part of their exemption to non-spouses. Most planning for U. S. citizens surviving spouses and other family members results in no tax liability on the death of the first spouse. This is true regardless of the size of the estate. The tax bite may be deferred to the second spouses’ death. A problem does exist. Most existing life insurance policies purchased prior to the Economic Recovery Tax Act (1986) with federal estate taxes in mind insure the life of the bread-earner spouse - usually the husband. If the husband does die first - the purpose for which the insurance was purchased may not materialize. There should be no federal estate tax on his death. A better idea would be to insure the younger of the two spouses. Premiums can be saved and regardless of whose life is insured, the proceeds can be available to pay the taxes resulting from the death of the surviving spouse. This is of massive importance where significant insurance programs are in place.
Many insurance companies provide a unique product called a Joint and Last Survivor Policy. This type of policy insures two lives and pays out death proceeds only on the death of the last of the two insured to die. As a method for only insuring the payment of death taxes, Joint and Last Survivor policies have merit. However, if life insurance proceeds are needed for any purpose, insuring the younger spouse may be the alternative. The decision whether to insure the younger of the two spouses to purchase a Joint and Last Survivor Policy can generally be reduced to an economic decision based on the premium costs of each product. The planner must "price compare" for his/her clients as different companies have different premium structures for each of their insurance products.
The decision between these two products may not entirely hinge on economics. There may be spouses who will elect to insure their young spouses rather than elect the joint and survivor policy. If the younger spouses do die first, then the other spouse will have the insurance proceeds to use and invest.
As is apparent, the Economic Recovery Tax Act has definitely changed the rules and created a huge opportunity for planners. It is now imperative that anyone who has purchased life insurance pre-1985 should have it reviewed and what better way to review its effectiveness than during an estate planning session?
Please remember that the discussion of the merits of Joint and Last Survivor insurance applies only to life insurance purchased solely to protect an estate already created.
Since the planner could be charged with improper policy comparisons, he/she should be particularly diligent while doing such comparisons. A complete analysis should be made of the relative costs between existing policies and new policies. Also if the new policy is less expensive - truly less expensive on an apples-to-apple basis - old policies should still not be canceled until the new policies are in force. The planner must be very careful to suggest to clients that they should drop an old policy, as the client could be uninsurable or very highly rated due to health problems.
As life insurance proceeds provide the fuel that powers many an estate planning "car,” most of the time the fuel mixture is taxed at the "pump" before it finds its way into the estate planning "vehicle.” A disadvantage associated with the purchase of life insurance is that the life insurance proceeds may increase the taxable estate of the policy owner. Upon the death of the insured owner, the life insurance proceeds will be included in the insured owner's estate for federal estate tax purposes. If the insured owns a life insurance policy on his/her life, all the life insurance proceeds will be included in his/her estate for a federal estate-tax purpose. In order to avoid federal estate tax, many clients have the life insurance on their lives owned by their spouses or others; then upon the death of the insured, the policy proceeds will be paid to the owner's beneficiary federal estate tax-free.
There are problems with this cross-ownership technique:
The goal sought by insurance policy cross-ownership - to avoid federal estate tax on Life Insurance Proceeds - is a good one. But there may be a better way to accomplish this goal. The planner can recommend the use of an irrevocable life insurance trust (ILIT) to own Life Insurance policies that insure an individual life. By using the ILIT, the insurance proceeds will be federal-estate-tax-free upon death. Also, if the client plans for the spouse, the ILIT will keep the proceeds out of the spouse's estate as well.
The ILIT is used to own an insurance policy whether it is purchased by the ILIT or given to it. The ILIT must be irrevocable. Once the trust is drafted and signed, it can never be changed. If the ILIT is not totally irrevocable or if the maker retains direct control over it, the insurance proceeds will not be federal estate tax free. By using an ILIT, three estate planning objectives are achieved:
In summary please note that ILIT drafting is not for rookies and should be implemented by an Estate Planning Professional. One small mistake in an ILIT, and all the tax benefits can be lost; remember, irrevocable means irrevocable!!
In some situations, using an ILIT to remove the death proceeds from estates, allows almost no access to the policy values that the insured may need for income purposes. Some financial planners recommend a private split dollar plan as a consideration, as it is designed specifically for a client who want to exclude the net death benefits from the estates of the insured and his/her spouse. At the same time, they want to have the policy values available to fund their personal needs at retirement. The split-dollar plan should be used only when a person wants to accomplish both of these objectives.
It must be pointed out that while the IRS has not ruled specifically on this program, every “component” of the plan individually has been supported to tax laws applicable. The areas involved are the split dollar part, plus estate, gift and income taxes.
The Private Split Dollar Plan (PSDP) is based upon a cash value life insurance policy that is split into its two parts: the insurance and the cash value components. (Sound familiar?) Then the part that will benefit most from the tax situations of each part then owns that particular component. For instance, the death benefit (pure insurance) is owned by an ILIT which is designed to not be included in either spouse’s estate. The insured’s spouse owned the cash value of the policy, which allows them to obtain policy values through the use of policy loans &/or withdrawals. Incidentally, one financial planner reporting on this method in an industry publication, points out that this is “particularly useful when one spouse has accumulated a significant amount of the overall assets, since significant asset re-balancing can be achieved.”
This program can be designed in several ways, but the most typical is where the insured established an ILIT before the application is taken. The trust then becomes one of the owners of the contract. Then a split dollar contract between the trust and whoever controls the cash values (the spouse or a revocable trust established by the spouse) is arranged.
Now, an application on the insured, which must be signed by the trustee and the spouse, can be submitted. It is highly recommended that a Variable Universal Life policy be used as the instrument, due to its flexibility and its features that fit the situation.
It must also be determined at this point as to which death benefit option to use (see previous discussion in Options). Option A is a level death benefit; Option B is an increasing death benefit. If Option A were chosen, then a decreasing death benefit would be paid to the trust because of the split dollar factor. This factor creates a payment of the interest of the spouse (the cash value) will be paid to the spouse in case of death of the insured. However, if the insured wants to maintain a level death benefit in order for the trust to meet certain estate liquidity needs, then Option B would be used.
Because there is a split ownership of the policy, there must also be split premiums. The insured would contribute the term cost (as determined by the insurance company) by giving it (gift) annually to the trust. Legally, letters are sent to the beneficiaries notifying them of their right to withdraw this gift. The beneficiaries would not, in most cases, withdraw this money; therefore the trustee of the ILIT will pay the insurance company for the ILIT’s share of the premium.
Secondly, the spouse will pay the balance of the premium due on the policy directly to the insurance company. If the spouse doesn’t have sufficient independent income to do so, the insured may make a marital gift of these funds to the spouse, who, for safety’s sake, should use a personal account to then make the premium payment to the company.
This process continues until the client either retires or needs the funds. The spouse may access the cash value by a series of policy withdrawals and loans and these funds can be used for any purpose including retirement funds.
The death benefit option can be changed after retirement because of the need for a continued amount of insurance to the trust. If Option B has been elected, a level amount of death benefit will be paid to the trust. However, if Option A has been elected, then policy loans and withdrawals will have to be made, which will reduce the cash value and death benefit. The results would be a continually changing (and decreasing) amount payable to the parties involved.
Regardless of which Option is used, since the trust is entitled to a death benefit, the actual amount that will be paid to the trust must be decided so that the trust can pay its share.
What is the end result of such a program? If it is put together correctly, a rather significant estate can be established for the surviving spouse (and other beneficiaries), which is tax-free because of the ownership by the ILIT. PLUS, it provides the spouse access to the cash values, which allows the spouses to accumulated funds on a tax-favored basis for retirement.
This plan can be extremely beneficial to any married couple who has enough income and/or wealth to benefit from the tax advantages. Planners who have used this program are adamant that both parties should have complete and total confidence in each other and in their willingness to act according to their wishes.
The survivorship access trust is a very flexible estate-planning tool. This allows clients to accomplish financial objectives that might not be available through more conventional irrevocable life insurance trust (ILIT) which is used particularly for affluent clients who want to preserve their assets for their family. When the ILIT is funded with a last-survivor life insurance policy, it is most effective in generating liquidity for a large estate.
There are limitations to an ILIT and unless care is taken in drafting the instrument, the cash value of a last survivor insurance policy within an ILIT is not allowed to be touched by the insured. A poorly drafted ILIT could also allow access to the cash value of the policy, which results in the inclusion of the death benefit in the insured’s estate. They have even been drafted to where the grantor could never recover contributions to an ILIT.
With proper drafting an ILIT can be designed that creates estate liquidity and at the same time, provides a source of tax-efficient assets when can be accessed through income tax-free loans for supplemental retirement income, or any other need. This is possible because of the Survivorship Access Trust, which (almost magically) changes the ILIT into a versatile financial planning tool. If it is drafted properly the trustee may make lifetime distributions to one or two insureds, usually a spouse. The insured with access to the cash values can use the money for any reason.
Some of these trusts include ascertainable standards, which obligates the trustee to make disbursements needed for the health, education, maintenance and support of the spouse beneficiary. The death benefits are then free of both income and estate taxes, thereby generating liquidity and preserving the estate. Some do not contain this provision, especially if there is a friendly relationship between the trustee and the insureds.
When setting up such a trust, there are certain things that must be accomplished.
The shared ownership plan revolves around single-life policies, and avoids the problem of the survivorship access trust wherein the insured is not able to access the cash value of the life insurance policy in an ILIT. Basically, there is one life insurance policy with two owners who share the rights, costs and the values of the policy, co-owned by one of two spouses in conjunction with an ILIT. The ILIT receives the death benefit free of estate and income taxes, and the co-owner gains tax-advantages access to policy cash values through withdrawals and loans (assuming the policy is not a modified endowment contract – MEW) and the policy remains in force.
An agreement is made between a “residual” owner and an “equity” owner when the life insurance policy is sold. The residual owner is usually the ILIT, and it receives most of the death benefit protection and pays the cost of that insurance coverage – and it can also own part of the policy’s cash value is so desired. The equity owner, who is usually the insured’s spouse, retains a death benefit equal to the cash value.
This method gives the clients greater flexibility to make the most of their financial resources.
Using life insurance to supplement retirement income usually requires the policy’s death benefit to be included in the insured’s gross estate and triggers an estate tax liability. Sharing the ownership of a life insurance policy overcomes that obstacle. The cash values of the policy continue to accumulate tax-deferred. The equity owner retains access to these funds through policy loans and withdrawals, and a substantial portion of the policy’s death benefits is removed from the client’s estate because the ILIT is the residual owner.
Depending on the type of annuity, there could be a taxable event when an annuity is used in estate planning.
If the annuity is a straight life annuity with no survivor benefits, then nothing is included in the deceased's annuitants gross estate. Since the monthly payment from the insurance company ceases at death. There is no value of the annuity to be included in the estate.
For Refund or Period Certain annuities that do provide some type of survivor benefits after the first annuitants death, the amount included is the amount refundable or the cost of a comparable contract that would provide the remaining annuity payment. Keep in mind if the decedent only paid a portion of the premiums, then only that portion of the annuities value that is attributable to the deceased's contribution is included in the gross estate.
Bruce purchased a refund annuity with his estate as beneficiary in case of his death. Bruce dies and leaves his estate annuity proceeds that actuarially could be purchased for $70,000 (Present Value). Bruce had paid premiums of $42,000 (60%) for this annuity. Therefore, only $42,000 is included in Bruce’s gross estate.
CHAPTER 11 – STUDY QUESTIONS
1. An annuity is included in the gross estate when it is payable
A. to the annuitant for life.
B. to a joint survivor who is still alive.
C. for a period certain and that time has expired.
2. Life insurance proceeds are included in a decedent’s estate if
A. the decedent had any incidence of ownership.
B. if the beneficiary was the decedent’s spouse.
C. a non-relative is named beneficiary.
3. A Trust is most often used when there is a large estate. The main purpose of a Trust is to
A. hold the monies and property for tax payments.
B. allow the trustee, established by the trust, to provide liquidity for the estate and have an orderly transfer of assets to the parties named in a Will.
C. distribute the money and property to a charity.
4. Property owned by the decedent can be transferred at death in the following manner
A. verbal agreement.
B. by a Will.
C. by federal law, dictating how the estate will be settled.
5. The Unlimited Marital Deduction
A. is not used in community property states.
B. avoids estate taxes ordinarily payable by the first to die in a marriage by passing on all assets to the remaining spouse.
C. allows the highest wage earner, in a marriage, to pass on earned income to the spouse.
6. Only one of the following types of annuities can be included in the gross estate.
A. An individual annuity, where the annuitant receives a payment until death.
B. An annuity between an employer and an employee, through a pension plan, where the payment ceases upon the death of the employee.
C. An annuity that is designated as a Joint & Survivor annuity.
7. To qualify for the Marital Deduction
A. the spouse must reside in the same state.
B. the deceased spouse must be a citizen or resident of the United States.
C. the spouse cannot be legally separated.
8. When a spouse leaves an estate that is sufficient to be taxed, under the estate tax laws, how and when must the tax be paid?
A. The tax must be paid in cash and within 9 months.
B. The tax must be paid in negotiable securities within one year.
C. If the estate were in tax free Municipal Bonds the estate would not have to pay taxes.
9. There are certain allowable deductions from an estate in order to arrive at the adjusted gross estate, which is the amount taxed. Which one of the following is an allowable de-duction?
A. Finance charges to pay off car.
B. Funeral expenses including tombstone, burial plot and transportation of the body.
C. Expenses of relatives and friends that come to the funeral.
10. Probably the most important reason that life insurance should be included in estate plan-ning is
A. while death is uncertain, life insurance is certain.
B. the taxation of life insurance proceeds is only 10% and this can be easily ab-sorbed by increasing the amount of insurance by 10%.
C. it will pay the mortgage first and the survivors do not have to contend with mort-gage payments.
ANSWERS TO CHAPTER ELEVEN REVIEW QUESTIONS
1B 2A 3B 4B 5B 6C 7B 8A 9B 10A