04/02/2000

Paying Estate Taxes with Tax-Free Dollars

In my articles about estate planning I have presented numerous solutions for avoiding and/or reducing estate taxes. While such approaches offer a great deal of protection from the tax man, they may not insulate your estate from all taxes. If your heirs might be facing a heavy estate tax bill that could be a burden to them and dramatically reduce the assets you wanted to give to them, there is a solution. It is called an Irrevocable Life Insurance Trust or ILIT ("eyelit" trust).

What is an Irrevocable Life Insurance Trust (ILIT)?

Yes, as the name implies it is a trust that holds a life insurance policy. Equally apparent is the fact that this kind of trust is irrevocable -- it can not be altered once established. Essentially, the death benefit from the insurance policy is removed from the estate of the deceased because it is held in the ILIT. Therefore, the death benefit passes on to heirs without any estate or income taxes due! The heirs can then use the proceeds from the policy to pay estate taxes and rejoice that Uncle Sam did not get all the families hard earned assets.

Furthermore, the death benefit can be designed to exceed potential estate taxes, thus serving as an immediate estate builder for the next generation.

Example: John and May Jones have a thorough estate plan prepared in which a By-pass trust and other estate reduction strategies are established. However, even after these arrangements are in place (and perhaps others to reduce estate taxes) it is apparent that the estate will still be subject to $750,000 in estate taxes. They decide to leverage their current assets to create a future lump sum that would cover the taxes. They establish an ILIT trust. The trust is the owner and beneficiary of a Survivorship Life Insurance policy covering both of their lives with a $750,000 death benefit. They make their children the beneficiaries of the trust. John and Mary will pay the insurance policy premium. Their wise attorney writes the trust with "Crummy" withdrawal powers. In doing so, all annual premium payments of $10,000 or less, qualify as a gift and are exempt under the annual gift tax exclusion. (As they pay the premiums they are further reducing and protecting estate assets and placing them in a tax shelter -- the insurance policy in the trust.) At the death of the last survivor -- John or Mary -- the insurance death benefit will go to their children and be available to pay the estate taxes. John and Mary will have leveraged some of their current assets to generate an estate and income tax free sum of $750,000 for their heirs!

A survivorship life policy is an ideal choice for most married couples to use in the ILIT. Both individuals and couples may also consider placing current permanent life policies into an ILIT trust. Single individuals who need additional coverage can purchase single life policies to place in the trust.

What is Survivorship Life Insurance?

Survivorship life insurance policies are also known as second-to-die policies because they are based on two lives, not one, and they pay the death benefit when the second person named in the policy dies. Generally speaking these policies offer attractive features: 1) they are usually less costly then single coverage on either spouse; 2) qualifying for the policy can often be based on the health of one individual, not both ; 3) death benefits may be guaranteed over the age of 100 ( an increasing possibility) without additional premium payments.

Most policies offer a variable return component. Your premium payment, after expenses is invested into a wide range of sub-accounts (mutual funds) offered by the policy. You select which funds you want to use and you can usually rebalance at any time without cost or tax consequences. A contract with exceptional fund returns over time, can mean a larger death benefit available to your heirs. Concerned that if your investment accounts do poorly your final death benefit might be less than originally anticipated? Not to worry,

Several companies guarantee the initial death benefit as long as certain funding requirements are met. If a variable contract conflicts with your willingness to take any market risk, you can structure a policy to be a blend of variable life coverage and term coverage. You can also purchase a completely non-variable policy. As these various options demonstrate, the range of policies available are designed to meet the personal estate needs of couples.

Estate Coverage for Singles

The survivorship life policies discussed above are for married couples. However, the insurance industry has not overlooked single, divorced or widowed individuals with estates subject to equally significant tax burdens. They have taken the best features in the survivorship estate plan products and created new single life policies designed to offer similar estate protection features.

Final Thoughts

Most people have a less than positive reaction to life insurance. At best, it is reluctantly purchased early in life only out of the acceptance of its necessity. Chances are, you fall into this group of people. However, if there ever was a time that life insurance not only made practical sense but actually can be used to your benefit, it is in estate planning. Insurance companies have created competitive survivorship life polices designed expressly for estate planning purposes. The use of these products in an ILIT trust make for a wining combination for you and your heirs.

Please send questions or comments to dcoffin46333@wradvisors.com.