life insurance trust/ownership/beneficiary to keep proceeds out of estate

[george2010]

you want proceeds from your life insurance policy that your wife will be the owner to go to your children and vice versa. The problem is since your wife owns "your policy", you have no control of that money.

you've got the idea. I'll own policy on my wife, which will pay to a testamentary trust created by my wife's will for the benefit of the kids. If for some reason, my wife were to change her will to remove the provision for the testamentary trust, then the insurance proceeds would revert back to me, which just puts me back where I started, with the proceeds of the life insurance coming to me and being subject to estate taxes when I die. And if my wife changes the beneficiary of the policy on me to her secret lover, well, I'll be dead when he gets the money so I hope they have fun together.

 

[TrustUser]

hi george,

my knowledge about life insurance is somewhat limited, because as an "investment", it stinks.

i know that with term insurance, "someone" is insured. if said "someone" dies, then the death benefit goes to the "named beneficiary".

when you say that you own her policy and she owns yours - that is a bit confusing to me.

are you taking out a policy in case she dies ? and that makes you the owner, she the insured, and whomever as the beneficiary ?

and then vice versa - she is taking out a policy in case you die ?

 

[george2010]

Hi TrustUser... you are correct, I will be the owner of a policy on my wife's life, rather than the more common scenario in which she would own her policy. And she will be the owner of a policy on my life. The beneficiary designation is still in flux... it is really the subject of this post.

There are a several benefits; I probably can't do justice to the topic, but if you google "life insurance ownership" there is a lot of info out there, eg. this one is pretty good: Life Insurance Ownership - Federal estate taxes

I agree with you that cash-value life insurance (eg. whole life, universal life, etc.) is usually a bad investment, but when punitive 45% estate tax rates come into play, even investments that "stink" can sometimes turn into winners if they help avoid the tax. So I have been looking at strategies for using large cash value life insurance policies both as a tool for reducing estate taxes, and a method of protecting assets (life insurance policies are generally exempt assets that creditors can't get at, so even if you have a car accident that results in a lawsuit that wipes you out, they won't be able to get the money in the life insurance policy). Too many issues to discuss here, but I'm starting to appreciate why big cash-value life insurance policies are attractive in some circumstances.

 

[TrustUser]

hi george,

i am somewhat familiar with life insurance trusts where the trust owns the insurance policy, and pays the premiums (as a means of avoiding estate taxes).

i know you mentioned having a will create an irrevocable trust ? now i am just talking out loud, hoping to ring some bells of others who may know more.

but it seems to me that a will only takes care of assets that are in one's estate. having the will create the irrevocable trust seems a bit sticky, to me - in terms of separation, which seems to be one of your big concerns.

would creating an irrevocable trust now be of help ? i am thinking you could then open up a bank account with whatever minimum amount that was necessary for no fees. and then simply have the insurance check sent to that bank account.

if i recall, the trustor can not be the trustee or beneficiary (in an irrevocable trust). but i see no reason why you could not have your mother, father, etc. be the trustor, if that helps.

i find this to be an interesting thread, so i hope some more dialogue continues.

 

[george2010]

but it seems to me that a will only takes care of assets that are in one's estate. having the will create the irrevocable trust seems a bit sticky, to me - in terms of separation, which seems to be one of your big concerns.

yes, that's exactly the issue that I'm concerned about. I just don't know whether it is possible to direct my trustee to receive funds and create a trust that has nothing to do with my estate. or will the IRS say that because my trustee touched the money, it must be considered part of my estate?

would creating an irrevocable trust now be of help ? i am thinking you could then open up a bank account with whatever minimum amount that was necessary for no fees. and then simply have the insurance check sent to that bank account.

Yes, and if I thought I could go online and use "LegalZoom" or similar to create such a trust for a few hundred bucks, then I probably would do exactly what you suggest... but I have looked through a sample of a life insurance trust that is pretty intimidating -- 22 pages long -- and I see tons of small, critical details in it so that even though the trust would be very simple in concept, I think trying to create it myself would be very risky. (opinions?)
To have a trust created professionally by my lawyer I think I'm looking at > $2000 in legal fees. That's not completely out of the question, but it just seems like throwing money away on a trust that in all likelihood will never be used.

 

[george2010]

i am thinking you could then open up a bank account with whatever minimum amount that was necessary for no fees.

I have been thinking more about what you said, and suddenly I had an interesting idea... I wonder what would happen if I did something as simple as set up custodial accounts for my kids under UTMA, say with one of my siblings as custodian... is there a way to set up the life insurance beneficiary designation to direct the money into that account, without causing the insurance company to have a conniption about paying the proceeds to a minor? The UTMA account wouldn't have all the nice spendthrift protections of a trust, so it's not ideal, but at least it might avoid estate taxes. Or alternatively, is there some other way to write a beneficiary designation that causes some kind of trust to be created post mortem without it being part of my will. eg. could I designate a beneficiary like "George's brother, as Trustee for the benefit of George's kids". Could that be enough to allow my brother to receive the funds, hire a lawyer, and establish a spendthrift trust for my kids? I've read numerous times that it is a bad idea to name minor children as life insurance beneficiaries, plus I really don't want to dump 1 M$ on my kids in an unmanaged, unprotected lump sum, but it would still be helpful to understand the pros/cons of trying to do that vs. some of the other approaches.

 

[Kiawah]

Yes, and if I thought I could go online and use "LegalZoom" or similar to create such a trust for a few hundred bucks, then I probably would do exactly what you suggest... but I have looked through a sample of a life insurance trust that is pretty intimidating -- 22 pages long -- and I see tons of small, critical details in it so that even though the trust would be very simple in concept, I think trying to create it myself would be very risky. (opinions?)
To have a trust created professionally by my lawyer I think I'm looking at > $2000 in legal fees. That's not completely out of the question, but it just seems like throwing money away on a trust that in all likelihood will never be used.

As previously indicated, go get yourself the manuals I referenced. They include a CD with all of the hundreds of documents in Microsoft Word templates, if you wanted to do it yourself. I am NOT necessarily suggesting that you do it yourself, but you seem fairly intent on investigating that option. If you read thru these examples, you will have a much clearer understanding.

The dialogue they give as to why you use or don't use certain sections/paragraphs will start to clear up the complexities that you are sensing.

 

[george2010]

I wonder what would happen if I did something as simple as set up custodial accounts for my kids under UTMA, say with one of my siblings as custodian... is there a way to set up the life insurance beneficiary designation to direct the money into that account,

partially answering my own question, I found one website that mentions this approach, so it looks like it would be possible to use language like,
"George's brother, as custodian for George's kids, under the Texas UTMA"
note that I could actually make the custodian my wife, which would be simpler, but then I would have to have two different UTMA accounts since we wouldn't know which of us was going to die first. Plus it would be a lot cleaner audit trail if the life insurance proceeds never got comingled with other funds my wife would be handling after my unfortunate demise.

here's a snippet from SBLI - Term, Whole, and Children Life Insurance Policy Holder Beneficiary

If you want to designate a minor as beneficiary, consider utilizing:

* "THE MASSACHUSETTS UNIFORM TRANSFERS TO MINORS ACT"

A "custodian" would be named for the benefit of the minor beneficiary under the Massachusetts Uniform Transfers to Minors Act.

WHAT DOES THE CUSTODIANSHIP LANGUAGE DO?

By utilizing the "as Custodian for" language, the prospective Custodian can act on behalf of the minor and can receive any funds owed to the minor. In the event of the Insured's death, the life insurance proceeds would be paid to this person who would receive such monies as Custodian for the minor child. Please consult your legal advisor for further information on this option.

 

[george2010]

As previously indicated, go get yourself the manuals I referenced. They include a CD with all of the hundreds of documents in Microsoft Word templates, if you wanted to do it yourself. I am NOT necessarily suggesting that you do it yourself, but you seem fairly intent on investigating that option. If you read thru these examples, you will have a much clearer understanding.

The dialogue they give as to why you use or don't use certain sections/paragraphs will start to clear up the complexities that you are sensing.

I may just do that... even if only for personal education so that, like you suggested previously, my discussions with my lawyer will be more effective.

Can you tell me if one of the documents included is a "partition of community property" agreement? In order to make the separate ownership of the life insurance policy work in a community property state, I need to execute an agreement that takes community property and "transmutes" it into separate property, which is then used to pay the insurance premiums. I've seen a couple of sample documents for that, and they appear quite straightforward; I think I could probably do that myself if I had a good template.

 

[TrustUser]

hi george,

from the link that you posted, it shows that the fed is trying hard to invalidate life insurance trusts.

i regularly create my own revocable trusts, but if i was gonna do an irrevocable life insurance trust, i would definitely need to do some more research. i certainly understand your hesitancy.

since you will probably use that particular knowledge only once, it might end up being more expensive for you to spend your own time than it would be to hire someone.

with revocable trusts, i knew i would be using that knowledge on an ongoing basis. not only did i not want to get stuck paying a fee every time, i did not want to solely rely on the knowledge of another professional. so i took the time to become knowledgeable, myself.

you mentioned about waiting to see what the feds do with estate taxes ? i suspect that by the time you die, those laws will have changed back and forth a dozen times. they are always monkeying with that. to wait and see what their next step is gonna be (which needs to be this year), does not seem to be helpful for you with your long-term plans.

if you had the trust created by a professional, and your 10-year term expired - might you not end up taking out another life insurance policy ?

 

[TrustUser]

for $225 you can get the elder manuals in loose leaf form from amazon. they are not the latest edition, but it gets updated twice a year. so you will always soon not have the latest edition.

dont know what it would cost to buy updates.

sounds like my computer manuals. we would get sent updates, so that we would replace the old page 10 with the new page 10, etc.

Amazon.com: Used and New: Elder Law Forms Manual: Essential Documents for Representing the Older Client (2 vol. set)

3,526 pages - ouch, that will keep you reading for the rest of your life - LOL.

 

[Kiawah]

Well these are two 4" binders, with very thin pages, so there are thousands of pages here. I have no personal interest in researching and understanding Life Insurance trusts, so let me do this simple piece for you. I will attach some of the text guidance overview, for section 12.4, which deals with Irrevocable Life Insurance Trusts. You determine if it wets your appetite. (I'm retyping, so apologize if any typo's).

"This form of trust is quite similar to Form 12.3, in that they share the goal of removing assets from the grantor's estate as a tax planning device. In this case, the trust will hold a life insurance policy on the grantor's life, either one purchased by the trust or a preexisting policy transferred into the trust. The grantor will make annual gifts to the trust as necessary to pay premiums on the insurance. As with Form 12.3, the trust includes a "Crummey" power to make sure that such deposits are considered completed gifts.

This planning strategy is indispensable where a client's taxable estate consists largely of non-liquid property, such as a business or real estate, that the family would not want to lose or sell at a loss in order to pay estate taxes. It can also be useful in other instances, depending on the clients' financial status and ages.

Very often, married clients purchase second-to-die policies for these trusts, since the premiums are lower in relation to the ultimate death benefit. This also makes sense since no estate tax will be due until both spouses die. This can be an important planning technique where a child is disabled and the parents want to make sure that sufficient funds exist to pay for his or her care indefinitely once the parents have passed away. Form 12.4.2 and Form 12.4.3 are used if the trust will hold a second-to-die policy.

Where the planning involves existing life insurance policies, they will not be considered outside of the grantor's estate unless the grantor survives three years after their transfer into trust.

This form is used if the policy is owned by the husband. It permits insurance policy proceeds to be used for the wife's benefit if she survives him. Form 12.4.1 is identical, except that the policy is on the life of the wife for the benefit of her husband.

This trust has a more complex "Crummey" power than that in Form 12.3, including a "five and five" power for the beneficiaries so that their failure to exercise a right of withdrawal will not be considered a taxable gift to the trust by them. See section 6. The grantor may not serve as trustee. His or her spouse may serve as trustee as long as there is also an independent trustee serving."

If you are interested, buy the binder. I am in no way associated with these guys, neither a lawyer nor financial adviser. I am just a consumer and have purchased this set of binders to do my own research and education, and have found it very helpful in many stages of estate planning (trusts/revocable and irrevocable, POA's, wills, medicaid planning, medical directives, health care POA's and living wills, etc). It's been the best $300 bucks I've ever spent.

 

[george2010]

you mentioned about waiting to see what the feds do with estate taxes ? i suspect that by the time you die, those laws will have changed back and forth a dozen times. they are always monkeying with that.

It's a good point, but on the admittedly slim chance that the end result of any discussion this year is some kind of extension of the 2010 rules, rather than reversion to 2009, I think I'd rather give things a few months to work themselves out, instead of committing funds irrevocably to an estate-tax avoidance strategy, only to have the estate tax repeal become permanent. Wishful thinking? sure. Impossible? nope.

It's too bad our politicians don't seem to realize that estate taxes, gift taxes, and generation skipping taxes are all abominably bad public policy (IMHO!), and that we would be much better served by policies that taxed estates simply based on accumulated gains on date of death. The current regime creates all sorts of distortions to normal economic activity, and rewards those with the most clever lawyers. Eliminating all three kinds of tax would avoid all the nonsense about "basis step-up", and all the various exemptions for estate, gift, and GSTT that have the end result of collecting far too little revenue for the IRS, while benefitting few other than the estate planning lawyers and CPA's. My uncle's estate that I referred to earlier had some assets in Canada, and those regulations were so much more logical and straightforward than the US or UK (which also has inheritance taxes). Everything was treated as if it was sold at fair market value on date of death. A final income tax return was filed paying the appropriate taxes on income and capital gains, and that was it. Beneficiaries received their inheritance with basis set on decedents date of death, so that was easy to keep track of too.

if you had the trust created by a professional, and your 10-year term expired - might you not end up taking out another life insurance policy ?

yes, perhaps. I don't think I'd buy any more term insurance, but as discussed above I might consider using a cash value policy for estate tax planning purposes. So establishing an ILIT now could serve the immediate purpose with the term insurance, and the long term estate planning purpose, making the initial expense much more palatable.

 

[Kiawah]

It's a good point, but on the admittedly slim chance that the end result of any discussion this year is some kind of extension of the 2010 rules, rather than reversion to 2009, I think I'd rather give things a few months to work themselves out, instead of committing funds irrevocably to an estate-tax avoidance strategy, only to have the estate tax repeal become permanent. Wishful thinking? sure. Impossible? nope.

If your goal was only tax avoidance, then waiting may pay off, I personally doubt it, but perhaps.

One of my primary goals was to pass on wealth to my kids, but do it in a way where they have less of a chance of blowing it....and they are able to ultimately pass it on to their kids. Funds are available to them for key events along the way, and then milestones previously mentioned assure that at least some money makes it out for many years to come. Nothing the government is going to dictate, is going to help me manage this key piece.

 

[TrustUser]

hi kiawah,

i have similar thoughts. but i have decided not to allow any withdrawal of principal, until such time that there are too many beneficiaries, such that it is no longer worth it to have the trust.

then the trust is simply distributed to the then beneficiaries.

i dont have the sort of wealth of many of the posters here, but i figure it will still be a good protection device for several generations.

a principal large enough to make a difference as far as keeping people fed, clothed, and sheltered. if they want fancy cars or trips to europe, they do so with their own EARNED MONEY.