Law Office
of
Tracy Christen Reimann
Attorney-At-Law
19 Myrtle Drive, Mahopac, New York10541
Telephone: (914)243-4933
Facsimile: (914) 243-4933
E-Mail:
Admitted in Jurisdictions:
State of New York
State of New Jersey
Washington, D.C.
Life Insurance and Estate Tax
As none of us have crystal balls and do not know what is going to happen with the Estate Tax in years to come, we must all “plan for the worst and hope for the best”.Life Insurance still appears to be an excellent planning technique as it is a method that individuals can provide funds to their loved ones in the event of their death absent estate taxconcerns.
The traditional method is for an individual to create a life insurance trust and fund the trust with either a single lifeor second-to-die policy payable at the death of the grantor or his spouse. Grantor annually transfers the dollar amount for the premiums to the trustee who in turns deposits the funds in the trust account and pays the premiums. At the death of the insured the policy proceeds are paid to the trust so the proceeds are available to the remaindermen to pay the taxes, purchase assets or to provide for their support. If the trust is created more than three years before the grantor’s death, the policy proceeds are not includible in the grantor’s gross estate. This is the same rule if the deceased made an outright transfer of ownership of an existing life insurance policy and did not retain any incidents of ownership. The insurance proceeds are not includible in his gross estate.
The trust can be as tailored to the particular grantor’s specifications as needed. For example, the trust can provide that upon the death of the grantor, the trust divides into two trusts. One trust which provides income to his spouse for life; the other a trust for the benefit of the grantor’s issue available to pay for their needs during their minority.
For utilization of the annual exclusion amount, the gift must be a gift of a present interest. The annual premium payments, in order to qualify for the annual exclusion, must be subject to a right of withdrawal. Most trust agreements contain what are known as “Crummey” Powers[1] which authorize the beneficiaries to withdraw for a certain time period the annual additions to the trust. A prospective problem with this is what happens if the annual insurance premiums far exceed the annual exclusion amount of $11,000.00 per year, per person. For example, Eric and Jill create a life insurance trust and the annual premiums are $150,000.00. The trust has four beneficiaries. At best, we can transfer $88,000.00 per year, per person without incurring any prospective gift tax exposure but this does not pay the entire premium. One solution could be for Eric and Jill to make larger transfers and consequently use more of their lifetime gift tax exemption.
Another option is to transfer the annual exclusion amount to the trust and loan the balance of the premiums to the trust. The loan is evidenced by a valid promissory note with a market interest rate. The interest and principal is payable at a set term in the future. The problem with this is two-fold. Are the grantor(s) going to have to do this annually? If so, they are running the risk of having a problem in the future possibly with the Internal Revenue Service trying to invalidate this transaction and bringing back the insurance proceeds into the taxable estate. Moreover, if the notes are not paid prior to death, the decedent has additional assets in his taxable estate and part of the insurance proceeds are being applied towards funding an estate asset. Additionally, what happens when the notes become due during the insured’s life and there is no (or limited) liquidity in the trust to pay-off the note?
Many times the preferable course is to transfer an asset when funding the life insurance trust that can generate sufficient income to pay the life insurance premiums. For example, rental real estate. The grantor obtains an appraisal for the property and then transfers the property into the trust by using some of his lifetime exemption from gift tax. If he is married, he can possibly split the gift with his spouse thusly utilizing a smaller portion of his lifetime gift exemption. The life insurance is excluded from the grantor’s estate and an appreciating asset is out of the grantor’s estate. Additionally, if the life insurance trust is drafted as an Intentionally Defective Grantor Trust for income tax purposes, the income, deductions, etc. will be attributable to and reported on the grantor’s income tax return.
[1]Crummey v. Commissioner, 397 F2d 82 (9th Cir. 1968)