19 Use of Life Insurance in Estate Planning Flashcards
Situations when entire Life Ins. policy proceeds included in decedent insured’s GE
- Proceeds payable to estate
- DI had general POA over policy
- DI gifted policy within three years of death
- DI had incidents of ownership in policy at DOD
- DI retained rights or reversionary rights in the policy
Value included in GE of policy owned on the life of another person
If policy paid up
- replacement cost, else
- interpolated terminal reserve plus any unearned premium
Value on other policy in GE if AWD elected and insured dies withing six months after owner’s DOD
GE will include the entire death proceeds rather than the value of the interpolated terminal reserve.
Second-to-die policies are especially subject to the risk of using the AVD
Ownership of Life Policies and Inclusion in GE
- Ownership by the insured: death benefit
- Joint ownership by insureds: contribution rule (spouse deemed 50%)
Ownership by someone not the insured in GE: Acquired outright by someone other than the insured and with an insurable interest
No inclusion in GE.
Policy transferred or assigned by insured within three years
The throwback rule will cause inclusion in the insured’s gross estate if the transfer was made within three years of the insured’s death
Policy transferred more than 3 years ago
Death benefit will not be included in the gross estate
Second person to die dies within three years of the transfer
Death benefit will be included in the gross estate of the second person to die.
If joint life (first-to-die) policy was transferred
- no inclusion (depends on ownership of policy).
- If the decedent made a completed transfer of ownership of a life insurance policy more than three years before death, the value of the policy, as of the date of the gift, will be included in the decedent’s adjusted taxable gifts (if greater than the annual exclusion)
Decedent transferred policy more than 3 years ago: Effect on adjusted taxable gifts
Value of the policy, as of the date of the gift, will be included in the decedent’s adjusted taxable gifts (if greater than the annual exclusion)
Life Insurance and Marital Deduction
- If entire ownership interest is gifted to the donor’s spouse, transaction qualifies for the unlimited gift tax marital deduction.
- If a gift is in trust for the spouse, transfer will qualify only if it is made in a trust that qualifies under the terminable interest rules [e.g., POA trust (A trust) or qualified terminable interest property trust (QTIP)]
Is Insurance Trust included in GE?
- If trust purchases policy directly, death benefit not in GE
- If insured transfers or assigns policy to the trust and dies within 3 years, the proceeds will be included in the insured’s GE
Advantages of Insurance Trusts
- Avoids probate
- Greater flexibility in distributions
- Can restrict use of funds by beneficiaries
- Trustee has more investment policy discretion
Unfunded Irrevocable Insurance Trusts
Grantor pays premiums at a later time
Typically used with the Crummey provision to avoid or reduce gift tax
Funded Irrevocable Insurance Trust
Grantor contributes cash or property to trust to pay premiums
Typically results in a large taxable gift in year one
Life Insurance and Gift Tax
- A policy transferred from the original owner to another without adequate consideration is a gift
- A person who buys a policy and designates another as owner at the inception has made a gift (if to the spouse, no consequence because of marital deduction).
Gift Tax of Life Insurance Transfer in Trust
When the owner transfers a policy to a trustee, owner has made a gift to the beneficiaries of the trust, assuming the gift is a completed gift
Indirect Gifts of Life Insurance
- Generally, the direct payments of premiums for a policy owned by another are indirect gifts.
- Gift tax may be avoided by gifting amounts not exceeding the annual exclusion or, if in trust, using a Crummey provision
Unholy Trinity
When three different people are the insured, the policy owner, and the beneficiary
Gift tax can arise at the death of insured if a noninsured owner and beneficiary of the policy are different.
There should never be three different people as the owner, insured, and beneficiary. Instead, the owner should have made either the insured, the beneficiary (if possible), or an irrevocable life insurance trust (ILIT) the owner. Alternatively, the owner could name herself as the beneficiary and then gift the death benefits over time
Gift Valuation of New or Paid-up Insurance
FMV on the date of the gift
Gift Value of Insurance with Premiums Remaining
Interpolated terminal reserve
+ any unearned premium
+ dividend accumulations
- minus loans against the policy
Gift Value of Universal and Whole Life Policies with Vanishing Premium
terminal reserve method
(because there can be no absolute assurance that future premiums will not be necessary to keep the policy in force)
Gift Value of Term Policies
unearned premium on the date of the gift.
Payment of Premiums and GSTT
The use of the annual exclusion may reduce gift tax (in a trust, use a Crummey provision).
Lifetime GSTT exemption may reduce or eliminate the GSTT
Transfer of Policy to a Skip Person
Generation-skipping transfer
Payment of Policy Proceeds to a Skip Person
Generation-skipping transfer
Joint-life (first to die) policies
Joint life (first-to-die) policies may cost less and provide more for couples with similar income levels or for businesses with several key employees.
- A joint life policy usually costs less than two policies but has only one death benefit, thus actually costing more per dollar of death benefit.
- The base policy may include an option of guaranteed insurability for the survivor (insured under a subsequent policy without evidence of insurability but at current rates)
Joint-life (second to die) policies
- Often used for a married couple to provide estate liquidity at the death of the second spouse to die
- Expectations are that marital deduction will be used at first death
- Inclusion in the gross estate of the second spouse can be avoided by eliminating incidents of ownership
Who Should Own the Life Insurance Policy?
Either
- the beneficiaries, or
- an irrevocable trust
Assignment may be effective, but the three-year look-back rule may defeat the objective of removing the proceeds from the gross estate.
Has the Beneficiary Changed?
Unless explicitly stated, the beneficiary has not changed!
Problems with Leaving Proceeds with a Beneficiary
- If the beneficiary is ill equipped (e.g., emotionally unsuited, legally incapacitated, or a minor) to receive and manage those assets. A trust may provide the needed management of the insurance proceeds.
- If the insurance policy fails to name a successor contingent beneficiary, the proceeds may end up back in the estate where they may be subject to creditor claims, estate tax, and probate.
Problems with Inadequate Life Insurance Coverage
Inadequate Estate and Liquidity Needs
