North Carolina Estate Planning Blog : North Carolina Estate Planning Lawyer & Attorney : Trust Counsel, PA : Trust Administration : Serving Chapel Hill, Durham, Raleigh, Pittsboro, Orange County, Chatham County

One common oversight I see when reviewing new clients’ financial status is failure to consider the estate tax impact of large life insurance policies. Most people know that life insurance proceeds are received free from income tax. What most don’t know, however, is that the proceeds are part of the insured’s estate for estate tax purposes if:

• The proceeds are payable to the insured estate, or
• The insured has any “incidents of ownership” of the policy, such as the right to change the beneficiary or access the cash value.

Life insurance proceeds of any amount can be paid to a U.S. citizen spouse free from tax. But – those same proceeds, or the value of items purchased with the proceeds, will be included in the taxable estate of the surviving spouse.

This may not be a problem for most of us at the current $3.5 million estate tax exemption. However, barring a change in the law, in less than 14 months the exemption will revert to $1 million, and the rate will increase from 45% to 55%. North Carolina adds another 16%. 

With a $1 million exemption even a $250,000 policy could be subject to estate tax when combined with the value of real estate, retirement accounts, and all the other assets of a decedent. Why take the chance of losing over half the proceeds to Uncle Sam? The solution is to create an irrevocable life insurance trust (ILIT) to own the policy. The proceeds will then escape taxation at the death of the insured, his or her spouse, and can be structured to avoid taxes at the death of the children or other beneficiaries are well.  In addition, the proceeds are protected from creditors and mismanagement by the beneficiaries.

If an existing policy is transferred to an ILIT, the proceeds will still be included in the insured’s estate for estate tax purposes if he or she dies within three years of the transfer, so it's best not to delay planning for existing policies.

ILITs must be structured properly to take into account various estate, gift and income tax issues, as well as state law.  Make sure you have an estate planning specialist prepare your ILIT and work with your life insurance agent.  ILITs are not inexpensive to create, but your beneficiaries could easily save several hundred thousand dollars or more.

• Email This
• Print
• Comments
• Trackbacks

Second-to-die life insurance has long been used by married couples to provide liquidity to pay estate taxes at the death of the second spouse to die.  Such insurance is less expensive and easier to obtain than two separate policies on the same individuals.

Now, life insurance that pays out at the first death is available. The Phoenix Companies, Inc., of Hartford, Connecticut, has released its Phoenix Joint Advantage universal life policy.  A single policy will insure two lives, covering couples who need cash for support when the first of them dies, and small business owners who need funds to purchase a deceased owner's interest.

The product has several options, such as a survivor purchase rider, which enables the survivor to purchase a new policy without undergoing further underwriting.

Given the usefulness of this type of policy for estate and business planning, I predict other companies will follow suit.

 

• Email This
• Print
• Comments
• Trackbacks

A while back I blogged about the advisability of trustees of irrevocable life insurance trusts (ILITs) reviewing the policy owned by the trust to help ensure the policy is still a sound investment and won't lapse.  Here's an article from the Wall Street Journal website covering a related topic, Keep Tabs on Insurance that Covers Estate Taxes.  The article doesn't discuss the use of ILITs to avoid estate taxes on the life insurance proceeds and further protect the funds for the beneficiaries, but in my opinion an ILIT should always be used for life insurance in a taxable estate (over $3.5 million in 2009).  ILITs are the best (estate) tax shelters around!  Even for relatively "small" $1,000,000 policy, a $2,500 trust could easily save over $500,000 in estate taxes.

• Email This
• Print
• Comments
• Trackbacks

In a Private Letter Ruling issued late in 2007, the IRS approved a clever technique to leverage a gift  to your favorite charity using your IRA and life insurance.  Developed by Douglas Delaney, a CPA and attorney in South Carolina, the "CHIRA®"  works something like this:

1.  The donor rolls over funds from a regular IRA to a self-directed IRA. The donor and the charity apply for the life insurance.
2. An loan (with market rate interest due) is made to the selected charity from the donor's new IRA. The loan is secured by a new life insurance policy purchased by the charity on the life of the donor.  The charity signs a promissory note payable to the IRA.
3. The charity assigns to the IRA the portion of the death benefit equal to the outstanding loan from the IRA.

Here's an example for the CHIRA® website:

A 74 year old donor decides to loan $1 million from her IRA to her favorite charity. The charity uses $30,000 each year to purchase a $1 million life policy on her life. The death benefit is used to fully repay the loan. Today, the charity will have $970,000 to allocate to their charitable purposes as well as a prudent interest and premium reserve. Whether it is cash to sustain their budget for a few years, or to put shovels in the ground two years early, the CHIRA® plan provides immediate capital without income tax to the donor.

The IRS concluded that (1) this is not a prohibited transaction within the meaning of Section 4975 of the Internal Revenue Code which would terminate the IRA under Section 408(a)(3), and (2) is not a prohibited investment in life insurance by an IRA under Section 408(a)(3) of the Code.  What this means is that this technique results in no taxable income to the donor.

However, this a complex, multi-step technique, and everything must be done correctly in order to achieve the intended consequences.  If you decide that a CHIRA® makes sense for you, make sure that you consult with tax counsel to ensure that you will face no adverse tax consequences.

Click "Continue Reading" for the full text of PLR 200741016.

Continue Reading...

• Email This
• Print
• Comments (1)
• Trackbacks

Failure to update one's beneficiary designations for life insurance, annuities and retirement accounts is all too common.  One of the more common problems stems from not changing beneficiary designations after a divorce.  The law does not automatically cancel beneficiary designations in favor of a former spouse.  This can cause a major disruption of one's estate plan, have unintended tax consequences and create conflict among family members.

Earlier this month the United States Supreme Court heard oral arguments in the case of Kennedy v. Plan Administrator for DuPont Savings.  This case involves a deceased father who never changed his retirement plan beneficiary after his divorce, and has pitted daughter against mother (the ex-wife).

Here is an excerpt from the Legal Information Institute Bulletin at Cornell University Law School:

"[T]he Supreme Court will determine whether a divorcing spouse must obtain a Qualified Domestic Relations Order to waive the right to receive an ex-spouse's pension benefits under the federal Employee Retirement Income Security Act ("ERISA"). A decision upholding the Fifth Circuit will make Qualified Domestic Relations Orders ("QDRO") the only method by which an ex-spouse can waive rights to pension plan benefits, while a reversal would permit voluntary non-qualified waivers as well. In either case, the Supreme Court's decision will impact pension plans, their employee plan members, and beneficiaries. "

 

Other common problems are naming minor children as beneficiaries, or not naming a new spouse if such is desired.

So, please check all of your beneficiary designations, and update them if necessary.  If you have any questions about the best way to handle the designations, consult with an estate planning attorney.  And finally, make sure that your designations are acknowledged by the institution!

 

• Email This
• Print
• Comments
• Trackbacks

Life insurance trusts (ILITs) are a popular estate planning technique used to shelter life insurance proceeds from estate taxes, creditors and mismanagement by beneficiaries. While the insured is alive, generally the only asset of an ILIT is the life insurance policy.  However, ILIT trustees have a duty to make sure that the policy is a sound investment, and may be liable to the beneficiaries if it is not.

So, for ILITs that have owned the same policy for several years, the trustee should ask the following questions:

• Is the policy performing as illustrated?  If the policy was obtained when interest rates were high, the initial illustration probably assumed a relatively high interest rate for the life of the policy.  However, in the last several years, interest crediting rates for universal life and participating life dividends have been lower.  Market downturns have also adversely affected the performance of variable products.  Failure to address this issues could cause polices to lapse.
• Is the policy sufficient for current needs? Changes in the insured lfe and beneficiaries lives, along with changes in estate tax and other laws, may make adjusting the death benefit advisable.
• Is there a more competitive policy available? Life insurance rates on similar policies tend to drop over time.  Longer life expectancies, lower mortality costs, and improvements in underwriting all contribute to lower current costs.
• Do newer policies offer better features? Limited guaranteed policies are now available, along with riders for return of premium, accelerated death benefits,  and long term care benefits.
• Is the insurance company financially strong?  Life insurance companies are rated for financial strength and stability by ratings services such as Moody's A.M. Best , and Standard and Poors.  Is your carrier's ratings decline significantly, consider switching to a stronger company.

Have an insurance professional conduct a few on the policy every few years to make sure that you are fulfilling your fiduciary duty and reducing the risk of future legal action by beneficiaries.

• Email This
• Print
• Comments (2)
• Trackbacks

Many of us could use more insurance for estate planning  purposes, such as financial security  for loved ones or payment of estate taxes. Most of us also have an unused asset, our insurance capacity. That is the amount of insurance for which we could qualify and is based on the projected value of our assets at life expectancy. For most people, the capacity is unused because of a reluctance to pay hefty insurance premiums.

Suppose you could obtain the insurance now, while you are healthy, and let a lender pay the premium?  With premium financing, using the life insurance contract as the primary collateral, that is possible.  The result is significant life insurance coverage at very little cost.

After obtaining the insurance, you will have several options options available:

• Your health may deteriorate and the best course of action could be to pay off all the loans and keep all the insurance.

• Or you could keep some of the insurance and sell some of the insurance. Then you could use the proceeds from the sold insurance to pay for the insurance you keep.

• Or you could just sell all the insurance coverage and keep the proceeds for your heirs.

When done properly, the financing programs allow you to buy now and decide later, based on the circumstances, how much coverage you may want.

The exit strategy of selling the insurance allows you to profit, even though you keep none of the insurance coverage.

To avoid estate taxes, the policies are owned by an irrevocable life insurance trust.

Everyone’s situation is unique, of course, and these plans can be specifically tailored for your circumstances.  However, premium financing is generally available only to those with multi-million dollar estates.  Folks of more modest means must get life insurance the old-fashioned way - by paying for it.

• Email This
• Print
• Comments (1)
• Trackbacks

This posting is compliments of my colleague Karen Brady in Colorado.  Important reading for anyone who has anything to do with life insurance, including owning it.  With life insurance, knowing and following the rules can save hundred of thousands, if not millions, of dollars versus remaining ignorant! Continue Reading...

• Email This
• Print
• Comments
• Trackbacks

            1.         What is a Life Settlement?    A life settlement is the sale of an in-force life insurance policy for an amount great than the cash surrender value of the policy and less than the face value of the policy.

           

Continue Reading...

• Email This
• Print
• Comments
• Trackbacks