8. Protecting Wealth and Providing a Legacy Flashcards
The key benefits and special uses of Life Insurance in Estate Planning
Life insurance proceeds are a guaranteed, quick source of funds for the payment of post-death obligations. They are not subject to probate proceedings. But if the policy is payable to the estate instead, the amount is included in the gross estate and is subject to creditors.
-can provide tax money for owners of non-liquid assets so a “fire sale” to raise cash under time pressure is avoided.
-can play an integral part in many buy/sell and business continuation arrangements.
-a “second to die” policy can also be used as an income replacement fund for a family able to financially withstand the loss of one breadwinner but not both.
Saving money is addition, compounding is multiplication, and life insurance is leverage.
Life Insurance ownership, beneficiary choices and ramifications in Estate Planning
If insured is the owner, the proceeds are included in their gross estate at death.
An Irrevocable Trust can be used to buy and own the policy to avoid estate taxation.
“Unholy Trinity” when three different parties are designated as the owner, insured, and beneficiary. Policy proceeds are subject to gift taxation.
Key Man Insurance
The business applies for, owns, and is named as the beneficiary of the policy bought for each key person within the business. Usually permanent, but can be term. Non-deductible premium payments. (Five times the employee’s annual salary or the salary times the amount of time that would be needed to find and train a replacement.)
Upon death of a key person, the policy’s death benefit is paid to the business, providing cash to cover the financial loss to the business. The plan may also then pay the key person’s salary to the family for a reasonable period of time.
If the person lives, the cash value of the insurance can provide funds to finance the individual’s retirement and can act as a nontaxable reserve for business emergencies. If a person resigns, the cash value of the insurance can serve as a replacement fund to offset the loss of the key person.
Second-to-Die Policies
Also called survivorship life. Pays only upon the death of which even spouse (or other insured person) dies last. Frequently, a need is anticipated strictly for tax cash.
If it is not necessary to keep premiums down, buying one traditional life policy might be a better overall deal. If you insure one spouse and they die second, same result overall. If they die first, the surviving spouse receives and invests the money until needed.
Buy-Sell Arrangements
An arrangement where business owners plan to purchase the interests of the other owners at a specific price upon certain events (i.e., death, disability, or retirement). Thus, the value of the business for federal estate tax purposes can be established and help ensure that heirs receive full value by guaranteeing sale and purchase price.
Cross-purchase: shareholders purchase insurance on each other’s lives in order to fund the buy-out of a deceased shareholder’s shares. Proceeds are tax-free, purchasing shareholders receive an income tax basis in purchase shares equal to the purchase price, and does not cause capital gains on the deceased shareholder’s estate.
Stock redemption: corporation purchases life insurance on each of the stockholders in order to fund the redemption of a deceased shareholder’s stock. One policy purchased per shareholder. No increase in income tax basis for increased share in corporation and a portion of death benefits received by corporation could be taxed.
Split Dollar Plans
Arrangements by which premiums, cash values, and death benefits of a regular insurance policy are split by two or more parties.
Collateral assignment: employee owns the policy and names a beneficiary. Employer pays nondeductible premiums. The policy’s death benefit is assigned to the employer as collateral for the employer’s interest.
Endorsement: employer owns the policy, and the employee receives a portion of the policy’s death benefit (total death benefit less the greater of cash value or premiums paid by the employer).
The proper view and use of Asset Protection in Estate Planning
Evolves from an estate plan that also offers asset protection.
It is not hiding assets.
It is not transferring assets for the purpose of defrauding creditors.
It is not, in and of itself, an estate plan.
It is not a one time shot or static arrangement.
“Keep my money during my lifetime.”
-protect against being sued
-protect personal assets from a failed marriage ending in divorce
-protect the nest egg for heirs
Note that having some assets exposed actually helps prove that the intent of the estate plan is for the efficient distribution of wealth at death.
Sole Proprietorship
Conducted by a single individual and therefore retains unlimited liability for the owner. Income is taxed at the owner’s income tax rate plus self-employment taxes on most operating income.
Easy to start and maintain.
Corporations
May be better able to obtain financing for growth, provides stockholders with personal liability protection, and any entity may own stock.
Subject to double taxation in that earnings are initially taxed at the corporate level and taxed again when distributed as dividends. More complicated and expensive to organize and maintain.
S Corporations
Avoids double taxation of profits. Profits passed through to owners are not subject to self-employment tax but if they are working in the business they must be paid a reasonable salary which is subject to employment taxes.
Limit of 100 shareholders. Preferred stock and/or other classes of stock with different economic rights are prohibited.
Partnerships
A pass-through entity. Flexible and easy to operate.
General partners control the partnership and are personally liable, and profits passed through to GP are subject to self-employment tax (but not for LP). GPs usually hold a minority interest to minimize potential legal recourse by creditors.
Limited partners are treated as investors only and do not have a voice or vote in operation. They are entitled to a pro rata share of distributions and are not legally liable or subject to self-employment taxes.
Limited Liability Partnership
A general partnership that has elected limited liability status. Combines all the advantages of a partnership with personal liability protection for partners. Similar to LLC.
Family Limited Partnerships
Parents set up an FLP and transfer capital assets in the partnership in exchange for partnership shares. They keep the GP shares and, over time, gift LP shares to their children using discounted valuation, removing the value of the gifted partnership interests from the estate. GPs have complete control.
Must be designed very carefully with legal counsel because the structure is complex and highly scrutinized by IRS.
Limited Liability Companies
A hybrid ownership structure that combines the best attributes of the corporate and partnership ownership structures.
A pass-through entity, provides personal liability protection, income and distribution allocations may be flexible (not pro rata), and multiple ownership classes are allowed.
Generally, all income is subject to self-employment tax.
The Irrevocable Life Insurance Trust
The Grantor creates the Trust, a Trustee is selected that manages the Trust, and beneficiaries are named who will receive the assets after the Grantor dies. The Trustee purchases an insurance policy on the life of the Grantor, with the Trust as owner and usually the beneficiary. When the insurance benefit is paid, the Trustee will collect the funds, make them available to pay estate taxes and/or other expenses, and then distribute them to the Trust beneficiaries.
The client can make annual tax-free gifts within the exemption amount to each beneficiary of the Trust. Each Trustee receives a Crummey Letter so they can opt to not receive the funds now and they can be used to pay insurance premiums.
