19 Use of Life Insurance in Estate Planning

Question 1

Situations when entire Life Ins. policy proceeds included in decedent insured’s GE

Answer 1

• Proceeds payable to estate
• DI had general POA over policy
• DI gifted policy within three years of death
• DI had incidents of ownership in policy at DOD
• DI retained rights or reversionary rights in the policy

Question 2

Value included in GE of policy owned on the life of another person

Answer 2

If policy paid up

• replacement cost, else
• interpolated terminal reserve plus any unearned premium

Question 3

Value on other policy in GE if AWD elected and insured dies withing six months after owner’s DOD

Answer 3

GE will include the entire death proceeds rather than the value of the interpolated terminal reserve.

Second-to-die policies are especially subject to the risk of using the AVD

Question 4

Ownership of Life Policies and Inclusion in GE

Answer 4

1. Ownership by the insured: death benefit
2. Joint ownership by insureds: contribution rule (spouse deemed 50%)

Question 5

Ownership by someone not the insured in GE: Acquired outright by someone other than the insured and with an insurable interest

Answer 5

No inclusion in GE.

Question 6

Policy transferred or assigned by insured within three years

Answer 6

The throwback rule will cause inclusion in the insured’s gross estate if the transfer was made within three years of the insured’s death

Question 7

Policy transferred more than 3 years ago

Answer 7

Death benefit will not be included in the gross estate

Question 8

Second person to die dies within three years of the transfer

Answer 8

Death benefit will be included in the gross estate of the second person to die.

Question 9

If joint life (first-to-die) policy was transferred

Answer 9

1. no inclusion (depends on ownership of policy).
2. If the decedent made a completed transfer of ownership of a life insurance policy more than three years before death, the value of the policy, as of the date of the gift, will be included in the decedent’s adjusted taxable gifts (if greater than the annual exclusion)

Question 10

Decedent transferred policy more than 3 years ago: Effect on adjusted taxable gifts

Answer 10

Value of the policy, as of the date of the gift, will be included in the decedent’s adjusted taxable gifts (if greater than the annual exclusion)

Question 11

Life Insurance and Marital Deduction

Answer 11

1. If entire ownership interest is gifted to the donor’s spouse, transaction qualifies for the unlimited gift tax marital deduction.
2. If a gift is in trust for the spouse, transfer will qualify only if it is made in a trust that qualifies under the terminable interest rules [e.g., POA trust (A trust) or qualified terminable interest property trust (QTIP)]

Question 12

Is Insurance Trust included in GE?

Answer 12

1. If trust purchases policy directly, death benefit not in GE
2. If insured transfers or assigns policy to the trust and dies within 3 years, the proceeds will be included in the insured’s GE

Question 13

Advantages of Insurance Trusts

Answer 13

• Avoids probate
• Greater flexibility in distributions
• Can restrict use of funds by beneficiaries
• Trustee has more investment policy discretion

Question 14

Unfunded Irrevocable Insurance Trusts

Answer 14

Grantor pays premiums at a later time

Typically used with the Crummey provision to avoid or reduce gift tax

Question 15

Funded Irrevocable Insurance Trust

Answer 15

Grantor contributes cash or property to trust to pay premiums

Typically results in a large taxable gift in year one

Question 16

Life Insurance and Gift Tax

Answer 16

• A policy transferred from the original owner to another without adequate consideration is a gift
• A person who buys a policy and designates another as owner at the inception has made a gift (if to the spouse, no consequence because of marital deduction).

Question 17

Gift Tax of Life Insurance Transfer in Trust

Answer 17

When the owner transfers a policy to a trustee, owner has made a gift to the beneficiaries of the trust, assuming the gift is a completed gift

Question 18

Indirect Gifts of Life Insurance

Answer 18

• Generally, the direct payments of premiums for a policy owned by another are indirect gifts.
• Gift tax may be avoided by gifting amounts not exceeding the annual exclusion or, if in trust, using a Crummey provision

Question 19

Unholy Trinity

Answer 19

When three different people are the insured, the policy owner, and the beneficiary

Gift tax can arise at the death of insured if a noninsured owner and beneficiary of the policy are different.

There should never be three different people as the owner, insured, and beneficiary. Instead, the owner should have made either the insured, the beneficiary (if possible), or an irrevocable life insurance trust (ILIT) the owner. Alternatively, the owner could name herself as the beneficiary and then gift the death benefits over time

Question 20

Gift Valuation of New or Paid-up Insurance

Answer 20

FMV on the date of the gift

Question 21

Gift Value of Insurance with Premiums Remaining

Answer 21

Interpolated terminal reserve

+ any unearned premium

+ dividend accumulations

• minus loans against the policy

Question 22

Gift Value of Universal and Whole Life Policies with Vanishing Premium

Answer 22

terminal reserve method

(because there can be no absolute assurance that future premiums will not be necessary to keep the policy in force)

Question 23

Gift Value of Term Policies

Answer 23

unearned premium on the date of the gift.

Question 24

Payment of Premiums and GSTT

Answer 24

The use of the annual exclusion may reduce gift tax (in a trust, use a Crummey provision).

Lifetime GSTT exemption may reduce or eliminate the GSTT

Question 25

Transfer of Policy to a Skip Person

Answer 25

Generation-skipping transfer

Question 26

Payment of Policy Proceeds to a Skip Person

Answer 26

Generation-skipping transfer

Question 27

Joint-life (first to die) policies

Answer 27

Joint life (first-to-die) policies may cost less and provide more for couples with similar income levels or for businesses with several key employees.

• A joint life policy usually costs less than two policies but has only one death benefit, thus actually costing more per dollar of death benefit.
• The base policy may include an option of guaranteed insurability for the survivor (insured under a subsequent policy without evidence of insurability but at current rates)

Question 28

Joint-life (second to die) policies

Answer 28

• Often used for a married couple to provide estate liquidity at the death of the second spouse to die
• Expectations are that marital deduction will be used at first death
• Inclusion in the gross estate of the second spouse can be avoided by eliminating incidents of ownership

Question 29

Who Should Own the Life Insurance Policy?

Answer 29

Either

• the beneficiaries, or
• an irrevocable trust

Assignment may be effective, but the three-year look-back rule may defeat the objective of removing the proceeds from the gross estate.

Question 30

Has the Beneficiary Changed?

Answer 30

Unless explicitly stated, the beneficiary has not changed!

Question 31

Problems with Leaving Proceeds with a Beneficiary

Answer 31

1. If the beneficiary is ill equipped (e.g., emotionally unsuited, legally incapacitated, or a minor) to receive and manage those assets. A trust may provide the needed management of the insurance proceeds.
2. If the insurance policy fails to name a successor contingent beneficiary, the proceeds may end up back in the estate where they may be subject to creditor claims, estate tax, and probate.

Question 32

Problems with Inadequate Life Insurance Coverage

Answer 32

Inadequate Estate and Liquidity Needs