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Estate Planning

In this world nothing can be said to be certain, except death and taxes.Benjamin Franklin
 

Well, life insurance can help:  it may not help you cheat death, but it may help manage taxes.

Certain estate planning steps we should all take, including the creation of a will and a health care proxy. However, if you have enough wealth and you expect your estate to be taxed at state and federal level, you may want to consider using life insurance in a trust called irrevocable life insurance trust (ILIT)

The top federal estate tax rate for 2014 and 2015 is 40%. Some states impose separate state inheritance and/or estate taxes. Sometimes heirs are forced to sell real estate, stocks, or a family business to raise cash to pay for taxes within nine months before estate taxes are due.

Your heirs may want to keep the home, jewelry, or other assets you have passed on but be forced to sell them to raise cash. Also, timing could be inappropriate due to bad stock market or slow real estate market, and they may be forced to sell assets at low values in order to settle the estate tax bill.

For 2015, gifts beyond the $14,000 annual exclusion from the federal gift tax reduce the federal lifetime gift and estate tax exclusion, currently set at $5,430,000 per person, and tax estates over that amount at a top effective rate of 40%.

 
 

ILIT can provide potential tax advantages, it needs to be set up and administered correctly.  It is a complex legal arrangement whose creation requires professional assistance.  It is most effective when in place prior to buying the insurance. Trust is irrevocable and once it is set up, you cannot terminate it, make changes to it, or withdraw assets.

Key advantages of an ILIT:

The assets owned by the ILIT will not be considered part of your estate for inheritance/estate tax purposes —meaning your heirs won’t have to pay estate or inheritance taxes on them.

  1. Premiums on the life insurance policy are paid by the trust, which means that the grantor must transfer sufficient money into the trust or pay directly on behalf of the trust to cover them.
  2. ILIT uses gifts made to the trust to pay for insurance premiums. These gifts are removed from the estate, and the benefits paid out to your heirs will not be included as part of your estate for tax purposes.
  3. Death benefit is not considered taxable income by the IRS (with or without ILIT)

How an ILIT works

  1. ILIT is an irrevocable trust that purchases a life insurance policy on the person who set up the trust, called the “grantor.” Grantor must be insurable.
  2. If a couple sets up the trust jointly, the policy is usually a “survivorship” or second-to-die policy, so the death benefit isn’t paid until both spouses pass away. In joint policies, only one person may be required to be insurable.
  3. When the grantor (or the surviving spouse) dies, the proceeds from the insurance policy flow into the trust and are eventually distributed to the trust beneficiaries, often the grantor’s children, grandchildren, or other family members.
  4. Pay out to the beneficiaries depends on how the trust is structured
    • The beneficiaries might be able to access the money soon after the insured person’s death
    • or the trust assets could be paid out incrementally by the trustee over time
  5. The projected tax liability of the grantor’s estate and the character of estate assets are the primary factors in deciding how much insurance to purchase.
  6. An ILIT provides the money to cover the taxes and gives the executor the flexibility to dispose of assets when it’s most advantageous to the heirs.
  7. It can also be a means to transfer sums of money to a particular beneficiary.
  8. The ILIT itself does not directly pay the taxes, but, rather, it can lend money or purchase assets from the estate.
  9. Most ILITs are funded through the purchase of a new policy rather than through the gift of an existing policy.
    • If an existing policy is gifted to the ILIT, the insured must survive for three years after the gift before the assets will be excluded from the insured’s estate for estate tax purposes.
    • If funded through the purchase of a new policy, proceeds of the policy will not be subject to estate taxes in the insured’s estate, even if the insured dies immediately after the ILIT’s purchase.
  10. Making a gift count
    • Premium payments for a policy owned by the ILIT are funded by gifts made by the donor.
    • To make sure that such gifts qualify for any available annual exclusions from the gift tax, beneficiaries of the ILIT are often given a short window after a gift is made—30 days is common—during which they may withdraw their share of the gift, up to the annual exclusion amount (in 2014 and 2015, the annual exclusion amount is $14,000 per beneficiary).
    • Actual withdrawal of the gift by a beneficiary could defeat the ILIT’s ability to use the gifted funds to make premium payments on the policy.
    • Beneficiaries must understand the overall estate planning goals for this approach to be fully effective.

Universal life or whole life insurance policy can help families provide funding to pay estate taxes and provide other benefits for protecting wealth.  It’s ready cash for heirs to pay for estate taxes on property or businesses.  Also life insurance will allow wealth to pass to your heirs outside your estate.

Choosing Life Insurance

For the life insurance within the ILIT, you can use

  1. Term life insurance
    • if you outlive the term of your policy, the ILIT is essentially worthless
    • generally not suitable for a permanent need such as estate planning
    • many companies won’t issue a term policy past a certain age, so a level-term period will typically not go beyond age 80
  1. Permanent insurance - primary purpose of the ILIT is to transfer wealth to your heirs, which will only happen if the policy is still valid.
    1. whole life –
      1. can provide a level premium for life
      2. provide a guaranteed death benefit
      3. accumulate significant cash value that can be accessed during the insured’s lifetime
    1. Universal life
      1. can provide a level premium for life
      2. more flexible in design than whole life policies
      3. less expensive than whole life

If your main goal is estate planning and you are focused on a guaranteed death benefit, then universal life may be the preferred choice, as those policies can often be designed to be.

If you are considering single premium life insurance, you may be creating a modified endowment contract (MEC).

  1.  A MEC will receive less favorable income tax treatment when loans or partial surrenders are taken from the policy during the insured’s lifetime than a life insurance policy that is not a MEC.
  2. Death benefits are taxed the same way for MECs as for policies that are not MECs.

Important considerations:

  1. ILIT could be in force for 20 years, 30 years, or even longer.  Therefore it’s vital for the grantor to have confidence that the issuer of the life insurance policy is a solid company and not likely to go out of business.
  2. You should be concerned about the long-term quality of the company issuing the policy.
  3. It’s crucial to compare credit rating of the life insurance companies and not just concentrate on the quotes given for the premiums. It’s not easy to get both a low rate and a high-quality company.
  4. Choosing an experienced trustee to administer the ILIT is vital
    1. Trustee need to be paying premiums in a timely fashion to keep the policy in force.
    2. Trustee needs to handle details such as notifying beneficiaries when money is contributed to the trust.

You’re not going to get younger and you are not going to get a better rate for your policy than at the age you are right now.  If you think you could benefit from an ILIT, talk to an estate planning attorney to explore the strategy in greater depth.

Why Wills and Estates

By planning your estate, you will be able to:

  1. Provide for your immediate family
  2. Couples/spouses want to provide enough money for their surviving spouse. Parents with children want to care for their children’s education and upbringing. If your children are under age of 18, both you and your spouse should have a will with guardians for your children, in case both of you die before they grow up. Otherwise you will lose all control.  Court will decide where your kids will live, who will make important decisions about the way your children live, about their education and about their money.

  1. Get your property to your beneficiaries quickly
  2. Some of the options are the following:

    1. insurance paid directly to beneficiaries, joint tenancy, and living trusts
    2. simplified or expedited probate
    3. provide partial payments to beneficiaries while a will is in probate.
  1. Plan for incapacity in case need raises
  2. Plan for possible mental or physical incapacity. Having a living wills and durable health-care powers of attorney will allow you to decide in advance about life support and pick someone to make decisions for you about medical treatment.

  1. Minimize your expenses
  2. Leave more money to your beneficiaries by transferring property to beneficiaries with an estate planning and by avoiding probate.

  1. Choose executors/trustees for your estate
  2. By choosing competent executors/trustees and giving them the necessary authority will save money, reduce the burden on your survivors, and simplify administration of your estate.

  1. Ease the strain on your family
  2. Take a burden from your grieving survivors and plan your funeral arrangements when planning your estate, limit the expense of your burial (if you feel like doing so) or designate a place.

  1. Help a favorite charitable organization
  2. Estate plan can help you support any charitable organization of your choice during your lifetime or upon your death.

  1. Reduce taxes on your estate
  2. Estate tax or inheritance tax your estate has to pay is a dollar that your beneficiaries won't get. A good estate plan can give the maximum allowed by law to your beneficiaries and the minimum to the government.

  1. Provide for people who need help and guidance
  2. Do you have an elderly parent, disabled child, or a grandchild whose financial stability or education you want to assure? You could create a trust fund for family members who need support if you won't be there to provide.

  1. Make sure your business continues smoothly
  2. Good estate plan can provide for an orderly succession and continuation of your business affairs by spelling out what will happen to your interest in the business.