"Money Matters" columnists Joel M. Blau, CFP, and Ronald J. Paprocki, JD, CFP, CHBC, discuss irrevocable life insurance trusts as well as what happens when someone dies without leaving a will.
Does it make sense to use life insurance to pay estate taxes?
A common dilemma faced by many high-net-worth physicians is that they don’t want their heirs to be burdened with estate taxes. So they take out a personally owned life insurance policy specifically intended to cover the tax bill upon their death. Unfortunately, the proceeds of the insurance policy wind up as part of the estate-thereby actually increasing the estate tax burden. The solution to this dilemma could be an irrevocable life insurance trust (ILIT).
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Many estates are subject to estate taxes: either the federal estate tax, or an estate or inheritance tax levied by the state. If you expect that your estate will fall victim to taxes, consider using an irrevocable life insurance trust. Generally, life insurance proceeds are included in the gross estate for estate tax purposes. However, if the life insurance is held in an ILIT, the proceeds escape estate taxation.
Even if an ILIT seems to make sense at first blush, you should not attempt to create an ILIT on your own given its many rules and guidelines. A comprehensive review of your estate and assets is necessary to determine whether an ILIT is the most appropriate estate-planning tool for your particular situation.
There are a couple ways to create an ILIT. Either an individual already has life insurance and wants to transfer the policy or policies into an ILIT, or the ILIT trustee purchases the life insurance. The proper type of life insurance for use in an ILIT can be determined with the help of an insurance professional. Be aware, however, that with a transfer of a current life insurance policy to an ILIT, there is a 3-year "look-back" period. That means if death occurs within 3 years of funding the trust with an existing policy, those insurance proceeds become subject to estate tax.
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The grantor (also known as the settlor, donor, or creator) must select the trustee of the ILIT. The trustee has important tasks to complete when managing the trust, most importantly not to let a lapse occur in the life insurance policy. The grantor must make a "present interest" gift to the trustee to pay premiums on the life insurance. The trustee must then notify the beneficiaries of their present right to withdraw the trust proceeds. This is known as "Crummey Powers."
More specifically, for 2016, the grantor can make an annual gift of $14,000 or less per beneficiary to the trustee for the premiums of the life insurance (unchanged from 2015). Any annual gift above the $14,000 per beneficiary would be included in the grantor's lifetime gift amount exemption. The trustee then writes a "Crummey Letter" to the beneficiaries informing them of their right to withdraw the gift amount.
Be aware that an irrevocable trust is just that-irrevocable. The grantor cannot alter the terms of the ILIT after its execution. The life insurance policy must stay in the trust. The policy may lapse or there may be a surrender value, but the grantor cannot change the terms. For example, if the grantor wanted to have different beneficiaries at some point down the road, that would not be allowable in an ILIT.
For information about how an irrevocable life insurance trust could work in your estate plan, consult with your financial-planning and estate-planning adviser to explore your options.
I’ve delayed writing a will. What will happen to my real estate at death?
If someone dies without having a will, their real property passes by "operation of law" to the next of kin pursuant to the intestate law of the state in which they reside. This is the law governing how property is distributed when someone dies without a will. State laws can vary significantly. When filing a petition for probate or estate administration, the court will want to know the value of the property and whether it is an income-producing property (for example, a rental property).
Depending on the property value, who is handling the estate, and who will inherit the property, the court will determine whether to restrict the sale of the property without court approval. The court will also want the executor or personal representative to account for any income generated if it is a rental property. A better solution is to implement a well-coordinated estate plan-one in which you decide in advance who will inherit your real estate.
Send your questions about estate planning, retirement, and investing to Joel M. Blau, CFP, c/o Urology Times, at UT@advanstar.com. Questions of general interest will be chosen for publication. The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.
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