Chapter 6 - Financial Underwriting: Pkanning for Personal Needs Flashcards

1
Q

Estate Planning

A

Traditionally focused on the distribution of the estate after death, however currently it is a lifelong process dealing with the acquisition of wealth and estate maintenance as well as the deliver of estate assets upon death to beneficiaries.

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2
Q

Advantages of a well planned estate

A
  1. Maximized wealth
  2. Efficient use of estate capital
  3. Tax Savings
  4. Appropriate asset ownership
  5. Assurance that estate property will be distributed according to decedent’s wishes
    6 Adequate estate liquidity.
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3
Q

Federal Estate Taxation - US

A

Usually only applied to large estates - only wealthiest 2%.

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4
Q

Arguments for estate tax

A
  1. Assists in the redistribution of wealth from the rich to the poor via government programs, providing assistance and opportunities not normally available to the economically deprived.
  2. The tax provides meaningful financial support for American democratic institutions of government and national programs
  3. The tax encourages support for charitable gifting strategy for reducing the taxable estate.
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5
Q

Arguments against the estate tax

A
  1. The tax disproportionately affects society’s most successful and productive citizens. It also penalizes business entrepreneurs looking to safeguard their life’s work and pas it intact to their heirs.
  2. Money and financial resources removed form the general economy via the estate tax cause a loss of jobs
  3. Tax-supports government institutions are generally less effective at promoting economic prosperity than a free-market economy.
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6
Q

Under the new estate tax rules

A

Amount an individual can be excluded from estate taxes, inclusive of gifts given during their lifetime is $5.45M for 2013 and increase for inflation to $5.34M in 2014. The top federal tax rate increased to 40% and remains in same in 2014.

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7
Q

Valuing the Taxable Estate

A

Net worth is often used as the basis from which to estimate whether an individual is subject to the estate tax. However estate tax is computer on the taxable estate, which is an amount determined by subtracting certain allowable deductions from the gross estate.

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8
Q

Gross Estate

A

The value of all property interests, real or personal, tangible or intangible, of an individual on the date of death to the extent of his or her interest in the property. Most property is valued at FMV.

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9
Q

Fair Market Value (FMV)

A

The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

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10
Q

Exceptions to FMV

A

Real property (land and permanent attachments) may not always have a ready market from which to estimate FMV. Under these circumstances, real property can be valued at the high of the highest price available or its salvage value (the disposal value of property at the end of its useful life).

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11
Q

Some real properties are s/t a special use valuation

A

Which is designed to value the property according to its current use, not its potential value if used for other purposes.
(i.e., farm is valued lower than a mall - if the land is perfect place for a mall, but there was no intention for this, then the valuation would be for that of a farm as intended).

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12
Q

Other special valuation situations (4)

A
  1. Publicly traded stock and corporate bonds are valued on the date of death or an alternate valuation date.
  2. US government bonds are valued at the date of death redemption price.
  3. Closely help corporation stock not s/t special use valuation is valued according to either the adjusted book value method or the capitalization of adjusted earnings method.
  4. Life insurance proceeds set aside for the benefit of the decedent’s estate or proceeds from policies owned by the decedent are taxed as part of the estate (many techniques exists to remove life insurance benefits from the taxable estate.
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13
Q

The adjusted Gross Estate

A

From the gross estate certain allowable deductions are made to arrive at the adjusted gross estate. These include:

  1. Allowable debts (such as mortgages)
  2. Funeral expenses
  3. Medical expenses
  4. Administrative expenses
  5. Losses during estate admin (such as the decline in value of an asset while the estate was being settled).
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14
Q

Marital and Charitable Deductions

A

These are subtracted from the adjusted gross estate to arrive at the taxable estate.
Property that is passing to the spouse of the decedent can be deducted completely from the adjusted gross estate.
These usually result in a survivor joint life insurance to offset he impact of the estate tax due at the second death.

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15
Q

Prudent use of the marital deduction depends on a numbers of factors including (5):

A
  1. the value of the property rights, known as the power of appointment. This is a property right reserved by the property donor that allows the donor to control who receives the property or benefits from the property.
  2. Partial interests in property, in which a property is owner or controlled by two or more individuals.
  3. Charitable remainder trusts, in which a beneficiary receives the income form the property but the charity gets the property itself upon the death of the .
  4. Guaranteed annuity interests, in which the charity gets income for a specific term, then the property passes to a beneficiary.
  5. Split gifts, in which a partial gift goes to a charity and the remainder goes to a beneficiary.
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16
Q

Estate Growth

A

Life insurance is intended to cover the liabilities of a death at an uncertain date, many estate planning sales allow for the expectation of estate growth.

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17
Q

Challenge to underwriters for estate growth

A

Determining the appropriate time frame and interest rate assumptions for any given estate.

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18
Q

Desirable estate growth projections should

A
  1. strive to adopt a reasonable rate of return commensurate with the average return on assets in the estate over time.
  2. Reflect the type of investment that make up the estate - conservative investments, such as bank certificates of deposit have a lower potential investment return than stocks or new business ventures.
  3. Adjust to the age of the estate owner - older individuals with fewer productive economic years require a shorter growth period.
  4. Assume that at least some investment income will be consumed by the estate owner and will not be complete reinvested - Retired individuals, or those with unusual medical expenses for themselves or family members can consume most or all of their available investment income; thus, estate growth for the elderly or those in ill-health can be minimal.
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19
Q

Estate Taxation - Canada

A

No estate tax.
Canada Income Tax Act provides that a deceased taxpayer is consider to have “sold” all capital property at fair market value immediately before death. Therefore gains will be handled on income tax return.
A capital gain will be incurred in situations where the FMV exceeds owner’s adjusted cost basis of the property (basically the original cost of the property). 50% will be included in the deceased’s estate terminal income tax return.
Otherwise capital gains exemption up to $750,000.

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20
Q

Capital property - Canada (2 categories)

A
  1. Depreciable capital property, the value of which declines over time, such as buildings, furniture, and machinery.
  2. Non-depreciable capital property, such as land, stock, and mutual funds.
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21
Q

Recaptured depreciation

A

If a property is actually worth more than its depreciated value, some or all of the depreciation can be added back to the value of the property through tax provisions.
Cottage cost - $60K, Depreciated value of $30K, but FMV of $70K. Pay tax on $40K.

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22
Q

Three separate jurisdictional premises of which can trigger the imposition of estate tax

A
  1. US Citizenship
  2. Residency or Domicile
  3. The situs or location of estate assets
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23
Q

Citizenship

A

IRS states that a tax is hereby imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the US. Citizens of the US are taxed on the value of their estate assets worldwide, regardless of where those assets are located.

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24
Q

Definition of a citizen includes

A
  1. All native-born citizens, and children born in the US to non-US parents.
  2. All naturalized citizens
  3. All citizens living abroad
  4. All individuals who have multiple citizenship status
  5. Former citizens and expatriates.
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25
Q

Residency or Domicile

A

A resident decedent is a decedent who, at the time of his death, had his domicile in the US. A person acquires a domicile by living there, for even a brief period of time, with no definite intention of later removing therefrom. Residence without the intention to remain indefinitely will not constitute domicile, no will intention to change domicile effect such a change unless accompanied by actual removal.

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26
Q

Residency and domicile is proven by 2 factors

A
  1. Physician presence

2. Intention to remain in the country

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27
Q

Situs of Estate Assets

A

The value of the gross estate of every decedent non-resident noncitizen of the US shall be that part of his gross estate which at the time of his death is situated in the US.
This means that assets owned in the US by foreign decedents are s/t estate tax, even if the decedent has never visited the US and has no residence in the country.

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28
Q

Rules that govern the imposition of the estate tax on foreigners including:

A
  1. The estate tax exclusion amount for non-resident aliens if $60K. Estate tax is due when a non-resident alien’s estate transfers US situs assets above $60K.
  2. The charitable deduction applied, but only to US charities.
  3. There is no martial deduction if the spouse is no a US citizen. However, if the spouse becomes a US citizen before the estate tax return is file, the deduction can be applied.
  4. Foreign death tax credit can be applied again the US estate tax.
    Estate tax treaties exist between countries to help secure risk of double taxation on the same estate assets.
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29
Q

Income with Respect of a Decedent (IRD)

A

Is the income the decedent earned but did not receive before his or her death. Examples:

  1. Uncollected salaries, wages, bonuses, commissions, vacation pay, and sick pay.
  2. Interest/dividends accrued but unpaid
  3. Uncollected lottery winnings
  4. Assets held in deferred compensation benefits such as qualified pension plans, profit sharing plans, SEP, Keogh, and IRAs.
  5. Outstanding stock dividends still owed to the decedent.
  6. Accounts receivable of a cash basis sole proprietor
  7. Rents/royalties accrued but not paid
  8. Unreceived gain from the sale of property.
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30
Q

IRD is taxed twice

A
  1. It is s/t income tax on either the decreased terminal income tax or, if the income has been passed by arrangement to an income beneficiary (such as a spouse or a child) it will be taxed as part of the income beneficiary’s income tax.
  2. It is subject to estate tax as part of the decedent’s estate.
31
Q

Trusts

A

Is a legal arrangement whereby property is held and managed for the welfare of a beneficiary. The principal advantage of a trust is that it provides an opportunity for competent asset management.
Can be set up to reduce estate tax liabilities and can reinforce the decedent’s wishes by specific trust provisions regarding distribution of income and sets in the trust to the beneficiaries.

32
Q

Trusts - US

A

In the US the premium for a life insurance policy held by a trust can be pain w/out tax penalty by using the annual gift tax exclusion which allows for a limited cash contribution to the trust without paying any federal gift tax.
A grantor can donate existing life insurance policy to the trust, but Grantor must survive 3 yrs or the benefits will revert back to the estate.

33
Q

Trusts - US - Internal Revenue Code requires the gross estate include an interest in any property (including a life insurance policy) that was …

A

(1) Transferred by the decedent within 3 years of death

(2) would have been included in the estate had such interest been retained by the decedent.

34
Q

Types of Trust

A
  1. Revocable trusts
  2. Irrevocable trusts
  3. Charitable trusts
  4. Generation-skipping trusts
  5. Dynasty trusts
35
Q

Revocable trusts

A

Type of living trust that is set up before the death of the grantor. No estate tax savings - grantor can undo the trust at any time. The grantor is liable for any income tax due on income generated within the trust and trust assets are vulnerable to the grantors creditors.
Avoid income tax liability.

36
Q

Revocable trusts - non-tax advantages

A

Grantor can select professional asset managers or can personally manage the trust assets
If a professional is secured, a revocable trust allows the grantor the opportunity to evaluate the manager’s performance.
Allows the grantor to enjoy the fruits of their generosity and the gratitude of the beneficiaries.

37
Q

Irrevocable Trust

A

Type of living trust and provide significant opportunities for tax savings as well as wealth and income shifting. Trust assets are removed completely from the grantors control (no incidents of ownership)

38
Q

Irrevocable Trust - Advantages

A
  1. Assets removed from the estate and put into the trust reduce the size of the estate and thus, the estate tax.
  2. Any appreciation in the trust asset happens outside of the estate. This also helps reduce the ultimate size of the estate at death
  3. Income generated by the trust assets is taxed to the trust, often at a lower rates than received by the grantor.
  4. The trust assets are not vulnerable to the grantor’s creditors.
39
Q

Charitable Trusts and Charitable Life Insurance Sales

A

Can exist theoretically - forever.
Irrevocable and must not name a specific individual or individuals. Must name a class as beneficiary.
Shifts assets out of estate reducing estate tax.

40
Q

Charitable Trusts and Charitable Life Insurance Sales -> Rule against perpetuities (not s/t to this state law)

A

Stipulates that private trusts can exist for a period of time not to exceed 21 years after the creation of the trust.

41
Q

Charitable Remainder Trust (CRT)

A

Allows a percentage of the trust assets to be paid out annually to a non-charitable beneficiary over a period of time. Can include property and stock with potential for large appreciation.
CRT pays regular income to the donor based on the value of the gift, for life.

42
Q

Life insurance sales for charitable purposes to continue contributions to a charity for a short time beyond death, criteria:

A
  1. What is the past history of giving?
  2. What has been the amount of the annual contribution
  3. Is the amount of the annual premium an unreasonable percentage of the individual’s income.
    Large amount are a concern due to being oversold and anti-selective.
43
Q

Generation Skipping and Dynasty Trusts

A

Used in situations in which the wealthy adult children of wealthy elders would not substantially benefit by an act of inheritance.

44
Q

Generation-Skipping Trusts (GSTs)

A

Avoid the cost of repeated estate tax payments that occur when assets are transferred through successive generations (with each transfer being subject to a separate estate tax) and also address any concerns the grantor can have about the effect that unearned wealth might have on the character of his or her descendants.
Amount up to a certain exemption ($14K currently/yr)
Funds can also purchase a life insurance plan on the life of the grantor.
S/t the rule again perpetuities (21 yrs).

45
Q

Dynasty Trusts

A

Flout the rule again perpetuities by creating a private trust that can last indefinitely.
Similar to GSTs they can be funded tax-free with generation-skipping exemption or annual gift exclusion amount.
Life insurance can be purchased.

46
Q

Trusts Canada - 2 types of trusts

A

Inter vivos

Testamentary Trusts

47
Q

Inter vivos

A

set up during the lifetime of the trust creator and are treated as separate taxpayer. These trusts pay income tax at a rate equivalent to the highest marginal rate application to individuals.
Life insurance provides an exception to this rule and avoids the 21-year rule.

48
Q

Types of Inter vivos trusts

A
  1. Spousal trusts - take advantage of Canada’s tax free marital rollover law, allowing property to be placed in the trust tax-free for the benefit of a spouse. Joint life insurance is often handled in this way.
  2. Alter ego and joint partner trusts are specifically targeted to citizens equal to or older than age 65.
    Alter ego - has 1 grantor
    Joint partner exists between spouses
    In both cases the grantor(s) of the trust receive any income and capital disbursements from the trust for their lifetime(s). When the grantor(s) dies, the trust contents are inherited by contingent trust beneficiaries, who, as in the spousal tryst, can have a tax obligation often paid for with life insurance.
49
Q

Testamentary Trusts

A

Different from Inter Vivos trust as they come into existence as a direct result of the death of the grantor. Death benefits paid avoid probate fees while also receiving special graduated income tax rates which are more advantageous then the usual rates.
Useful trusts for minors or permanently disabled children.
Usually wholly and partially with life insurance.

50
Q

Advantages of an offshore trust

A
  1. “Tax havens”. May not require to pay income, capital gain, or estate tax
  2. It does not recognize foreign judgements (divorce, lawsuit, etc. Creditors must file suit in the jurisdiction where the trust is located)
  3. Can avoid or extend the rule against perpetuities
  4. The trustee of an offshore trust can purchase foreign securities without adhering to SEC reporting requirements. Can also invest in assets not available in the US under the “prudent person rule” or statutory legal list of qualified investments. The list of possible investment includes venture capital funds, hedge funds, foreign securities, patents, and real estate.
  5. Trustee can purchase life insurance from either a domestic or an offshore carrier.
    They are also not subject to mainland regulations and have lower internal costs, and more flexible investment options for UL plans, and lower commission rate.
51
Q

Offshore Trust - Private placement variable universal life insurance (PPVUL)

A

Offer investment opportunities not available to the general public. Private offers to accredited investors and groups of up to 100 persons. Accredited investors are individuals with investments of $5M or more or an institution with investments of $25M or more.

52
Q

Family Limited Partnership - US

A

Modified business partnership comprised solely of family members and has characteristics common to both regular partnerships and corporations. Comprised of 2 classes of partnership -> (1) general partners, (2) limited partners

53
Q

Family Limited Partnership - General partners

A

Responsible for daily management of the partnership. Often elders who contribute the property held within the LFP.

54
Q

Family Limited Partnership - Limited Partners

A

Play a more passive role and have no daily management responsibilities. Often children and younger family members.

55
Q

Family Limited Partnership - Advantages

A

Liability protection against creditors.
The creditor of a partner cannot reach into a partnership and claim certain partnership assets.
Also, assets place in the FLP are shifted out of the estate of the granter with a subsequent drop in estate value and additional tax benefits created due to wealth and income shifting.

56
Q

Life Insurance and FLP

A

A funding vehicle for the FLP or as part of a buy-sell agreements that exists between partners.

57
Q

Underwriting Elderly - Justifiable needs for insurance are:

A
  1. Estate Transfer
  2. Continuing income
  3. Funds for final expenses
  4. Stock repurchase
  5. Management and protection of accumulated assets.
  6. Changing investments from growth to quality
  7. Long term care needs
58
Q

Underwriting Elderly - Attainability

A

Determining if the desired objective can be accomplished in the remaining normal life span of the proposed insured.

59
Q

Underwriting Elderly - Estate creation

A

The use of insurance as the sole means of providing an inheritance received by the heirs where none would otherwise exist or using insurance to allow heirs to inherit considerably more than would normally pass to them.

60
Q

Underwriting Elderly - IOLI and STOLI (investor owned or stranger owned policies)

A

The motivation for the insurance purchase is the quick sale of the policy after issue to a group of investors who have no insurable interest in the insured and seek a financial gain upon their death.
Can look legitimate.

61
Q

The purpose of life insurance in estate planning is three-fold

A
  1. Life insurance can replace assets lost due to estate transfer costs. In the US, this loss occurs d/t the estate tax. In Canada, capital gains and the recapture of capital cost allowance reduce estate value, which, in both countries, can be restored with life insurance.
  2. Life insurance can transform assets as is the case in a buy-sell agreement for FLP or the purchase of liquid asset from an estate by a trust, with life insurance proceeds.
  3. Life insurance can increase assets, as happens in private placement insurance
62
Q

Revocable Trust

A
  • Assets placed in trust - managed on behalf of trust beneficiaries
  • No estate tax savings accrue to trust grantor; grantor retains control over trust assets
  • Non-tax advantages include control of assets within trust by grantor, choice of trust manager by grantor, enjoyment grantor has in providing benefit while still living.
63
Q

Irrevocable Trust

A
  • Assets placed in trust - managed on behalf of trust beneficiaries
  • Assets placed in trust - removed from the estate of grantor
  • Grantor does not retain control over trust assets
  • Any taxable appreciation in value of asset, happens outside estate of grantor.
  • Any income generated by trust is taxed to trust, not grantor
  • Trust assets not vulnerable to grantor’s creditors.
64
Q

Irrevocable Life Insurance Trust (ILIT)

A
  • Type of irrevocable trust in which life insurance policy on grantor comprises trust assets.
  • Policy and death benefit removed from estate of both grantor (insured) and beneficiary (often spouse)
  • Beneficiary/spouse receives death benefit during his/her lifetime
  • ILIT can loan money to estate or grantor to pay estate taxes
  • At death of beneficiary/spouse, trust assets can be passed to children without tax consequence.
65
Q

Charitable Trust

A
  • Type of irrevocable trust
  • Assets place in trust - managed on behalf of the charity
  • Life insurance policy on life of grantor can be made asset of trust
  • Not subject to Rule Against Perpetuities
66
Q

Charitable Remainder Trust

A
  • Type of charitable trust
  • % of trust assets paid out annually to non-charitable beneficiary
  • Life insurance can be purchase on life of grantor with trust’s annual payments
  • When grantor dies, charity receives trust assets; insurance proceeds given to non-charitable policy beneficiaries.
67
Q

Generation Skipping Trust (GST)

A
  • Trust assets benefit grandchildren and later generator of grantor
  • Trust asset equal GST exemption amount
  • Trust assets can purchase life insurance contract on life of grantor
  • Insurance policy proceeds fund trust at death of grantor
  • Subject to Rule of Perpetuities
68
Q

Dynasty Trust

A
  • Private trust not s/t Rule of Perpetuities
  • Can be funded like GST with exemption amount
  • Can purchase and benefit from life insurance on trust grantor, like GST
  • Not available in all states.
69
Q

Inter Vivos Trust

A
  • Trust set up and funded during lifetime of grantor
  • Trust pays taxes on an retained earnings at highest rate
  • Trust s/t 21 year rule, except when trust purchases life insurance
70
Q

Spousal Trust

A
  • Type of inter vivos trust
  • Ultimate beneficiaries of trust often offspring of previous marriage
  • Joint life insurance plans commonly used to offset taxes due upon death of second spouse
71
Q

Alter-ego Trust

A
  • Type of inter vivos tryst
  • Used by citizens 65 or older
  • Just one grantor
  • Trust income given to grantor until death; then trust assets inherited by contingent beneficiary
  • Life insurance may be needed by contingent beneficiary to pay death taxes.
72
Q

Joint partner Trust

A
  • Type of inter vivos tryst
  • Used by citizens 65 or older
  • Just one grantor
  • Used by spouses, common-law spouses and same sex couples.
  • Trust income given to grantor or spouse/partner until death; then trust assets inherited by contingent beneficiary
  • Life insurance may be needed by contingent beneficiary to pay death taxes
73
Q

Testamentary Trust

A
  • Used for benefit of minors or permanently-disabled children
  • Trust is activated at time of death of grantor
  • Testamentary trusts receive favourable tax treatment
  • Often wholly or partially funded with life insurance.