By Boyce F. Lowery, CLU, ChFC
With the very likely tax changes coming soon, an increasing number of people heretofore unaffected by estate taxes will find themselves in a bigtime quandary. Getting one’s planning in order has probably never been more important than it is right now. Today, we’ll focus on estate planning.
Estate planning can sound intimidating, and many individuals have put off this task while focusing on other financial priorities. While your unique financial situation may make estate planning a bit more involved, remember that it’s simply planning ahead for one or more events that will occur at an unknown time in the future.
Where people can get tripped up is forgetting that a lot can happen between the time of implementing the estate planning strategy and when the strategy actually goes into effect. That’s why flexibility is key. For example, tax laws may have changed, family dynamics may be different, and financial goals certainly have a way of shifting from time to time. As families focus on developing a plan to minimize taxes, protect assets from creditors, and keep wealth in the family, it may also be smart to consider strategies that offer considerable flexibility in light of the foregoing.
By emphasizing flexibility, strategies can be implemented to address wealth-transfer goals while seeking to retain the ability to adapt to changing circumstances. These may include retaining the right to:
- Continued use and enjoyment of assets/property
- Continued access to income
- Control and manage assets/property
- Change future recipients of income, assets, and property
Given the changes being considered by the new administration and the Democrat-controlled House and Senate, the vast majority of professional planners believe the window of time is growing very short to take full advantage of the current tax and estate planning laws. I’ll repeat; there has never been a better time for planning than at present. We believe it is very likely that some of the estate tax planning techniques and exemptions available today won’t be around on January 1, 2022. It is even possible that any changes could be retroactively made to January 1, 2021, though we believe that is unlikely.
Estate Planning Strategies and Techniques Available Today
Let’s take a look at potential strategies that might apply to your situation.
Spousal Lifetime Access Trust (SLAT)
- An irrevocable trust is established by one spouse (the grantor spouse) to benefit the other spouse (the beneficiary spouse) and children.
- The Trust purchases a life insurance policy on the life of the grantor spouse. It can also hold other assets though one should be careful having income producing assets in a Trust. Life insurance can work very well because of its tax attributes and other features.
- While both spouses are alive, the trustee of the SLAT may make distributions to the beneficiary spouse and their children for their health, education, maintenance, and support. There might be a different ascertainable standard used for distributions. The trustee may use withdrawals and/or loans from the life insurance policy or other trust assets to make the distributions which would be free of any taxes to the Trust or beneficiaries.
- Upon the death of the grantor spouse, life insurance death proceeds will be paid to the Trust. The Trust may continue to provide income to the beneficiaries or may terminate and distribute the remaining income and principal to the beneficiaries, depending on the terms of the trust.
- A SLAT provides advantages similar to a traditional irrevocable trust; e.g., assets contributed to the trust are removed from the estate of the grantor spouse and beneficiary spouse and free from estate taxes, trust property may be protected from potential creditors, professional management of trust assets, etc.
- The grantor spouse retains access to trust income “indirectly” through the beneficiary spouse.
If dual SLATs are considered, care must be taken to assure the death benefit proceeds are excluded from each spouse’s gross estate upon their death. If each spouse’s SLAT is identical, there is a risk the IRS may consider them “reciprocal trusts” and include the death benefit proceeds in their estates. Clients should consult with their legal and tax advisors if considering this strategy. There are ways to have SLATs for both spouses, but care and experience is required in the drafting and implementation.
- A married couple acquires a life insurance policy on the life of one of the spouses.
- The spouse with the shorter life expectancy is named the initial owner, and the spouse with the longer life expectancy is the insured.
- A standby trust is named as the contingent owner of the policy. Upon the death of the owner spouse, the policy automatically changes ownership to the standby trust. The trustee will then change the beneficiary of the policy to the trust itself.
- Upon the death of the insured spouse, the death benefit proceeds will be paid into the standby trust.
- The standby trust may be specifically designed to achieve your family’s wealth-transfer goals. Working with your professional legal advisors, you may select the trustee, choose the beneficiaries, and dictate the timing of future distributions.
- An alternative is to have the policy owned by a revocable standby trust that automatically converts to an irrevocable trust after the first spouse passes away.
- Upon the death of the insured spouse, the death benefit proceeds will not be included in the estate for estate tax purposes.
- Premiums paid into the policy will not be subject to federal or state gift taxes, since one of the spouses will own the policy directly.
- When properly drafted and administered, the standby trust may provide a level of creditor protection.
- It provides an opportunity to delay “irrevocable” decisions related to your estate planning strategy. This may be especially attractive to younger couples.
- While both spouses are alive, they will have full rights in the policy, including access to policy cash values through loans or withdrawals, the ability to change the beneficiary, and the ability to take advantage of all other policy features and riders.
- Each spouse states in their will, or through a beneficiary designation in their revocable trust, that all, or a portion, of their estate shall pass to their spouse at their death. Upon the death of one of the spouses, the surviving spouse may disclaim all or a part of the assets they are to receive as a result of the death of his/her spouse.
- Based on the terms of their will or trust, the assets disclaimed are then placed in a trust (the disclaimer trust) which may provide income to the surviving spouse for the remainder of their life, with the remaining balance passing on to their children, grandchildren, or other family members at the surviving spouse’s death. The surviving spouse may take full ownership of assets not disclaimed.
- Life insurance may be a vital part of a family’s overall estate plan—providing funds to help pay estate taxes, funds for family members to acquire the family business, or simply providing a flexible asset that is easily allocated among heirs. Life insurance death benefits may be disclaimed into a disclaimer trust, but it is important that the beneficiary does not take receipt of the death benefits before disclaiming them. It is also important that the beneficiary designation on the life insurance policy specifically states that the contingent beneficiary is the disclaimer trust.
- With estate tax exemptions fluctuating between $675,000 and $11,700,000 between 2001 and 2021, traditional rigid planning may not be appropriate. The disclaimer trust provides a tremendous amount of flexibility to deal with estate taxes regardless of what the laws are when a transfer of wealth occurs.
- Allows the insured(s) to retain access to cash surrender values through withdrawals and/or policy loans during their lifetimes.
- Does not require utilizing annual gift tax exclusions or lifetime gift tax exemptions when premiums are paid.
- Simple plan to implement.
- Allows decisions to be delayed, taking into consideration potential changes to tax laws, family dynamics or personal financial needs.
Irrevocable Life Insurance Trust (ILIT)
- The estate planning advantages of life insurance may be enhanced by having the policy owned by an ILIT. An ILIT is a separate entity designed to own the policy and receive the death benefits. The trustee is given control over the policy and will be responsible for carrying out the terms of the ILIT for the benefit of named beneficiaries (typically the insured’s spouse, children, or other family members).
- It is a flexible document in that the grantor (the individual who establishes and funds the trust), working with their attorney, tax advisor, and financial professional, may decide how the trust will operate during their lifetime and how trust income and property will be distributed after death.
- One issue with the insured directly owning the policy is that the death benefit will be included in their estate for estate tax purposes. When an ILIT owns the policy and is designed and administered properly, the death benefits will be excluded from the insured’s estate. The insured may gift (or loan) money to the trustee, who will then use those funds to pay the premiums. When properly designed and administered, a gift to the ILIT may escape the federal gift tax as well.
- ILITs allow death benefit proceeds from life insurance to escape estate taxation.
- An ILIT can be drafted with a certain amount of flexibility, to wit:
- The trustee may be given the right to “swap” assets. For example, if the grantor would like to remove a life insurance policy from the ILIT, the trustee and grantor may agree to swap ownership of the policy back to the grantor in return for assets of equal value.
- The trustee may be given the right to loan money to the grantor.
- A beneficiary may be given a limited power of appointment which grants them the right to name the party to receive their interest in the trust after they pass away.
- A trust protector may be named. This is an individual or entity that is granted the right to make trust changes in order to ensure the grantor’s wishes are carried out. Duties are spelled out in the trust and may be broad or limited. The trust protector may be given the power to modify terms of a trust and address unforeseeable events, such as changes in tax laws or family dynamics.
- The ILIT may be terminated or modified based on state laws. A termination or modification may require the signatures of all beneficiaries, the grantor, and the trustee.
- In some states, the ILIT may be permitted to go through the process of decanting, which involves taking all the principal out of the existing ILIT and placing it in a new ILIT with provisions that are more suitable to the grantor’s goals.
- The grantor and/or the beneficiaries may be given the right to change trustees. Pursuant to IRS Revenue Ruling 95-58, the right to remove the trustee does not cause estate tax inclusion as long as the new trustee is not “a related or subordinate party.”
- The trustee (or a trust protector) may be given the right to change the trust situs (i.e., governing state law). This may be appropriate in order to take advantage of laws in different states that may be more beneficial.
- A spouse may be included as a beneficiary, and the trustee given the discretion to distribute income to the spouse (typically limited to distributions for health education, maintenance, and support—which may be broadly defined).
- If your estate planning goals include providing annual income to your spouse for life and ensuring your children or family members benefit from the estate you have built, then a QTIP (Qualified Terminable Interest Property) trust may help to accomplish those goals.
- A QTIP trust requires all trust income to be distributed to a surviving spouse (and solely to that spouse), during their life, on at least an annual basis. The remaining balance of the trust after the surviving spouse’s death then passes on to designated beneficiaries (typically children or grandchildren). The grantor (the spouse who establishes the trust) is the only person who may decide who the remainder beneficiaries may be. The surviving spouse may not change who is to receive the remaining trust balance.
- A QTIP trust may be established and funded during your lifetime or at your death. For example, a married individual may establish and fund a QTIP trust and have the trustee use a portion of the trust principal to purchase cash value life insurance on their life. The trustee may distribute income generated by other trust investments and/or may withdraw cash value or take loans from the policy to generate additional income to the spouse if needed. This provides a level of flexibility as to when distributions are made as the trustee may decide when to take withdrawals or loans from the policy. When the grantor/insured passes away, the trust will receive the death benefit proceeds and the trustee may distribute trust income to the surviving spouse or make distributions to the grantor’s chosen beneficiaries if the spouse has already passed.
- A second option for incorporating a QTIP trust is to establish and fund the trust upon death. This could be done simply by providing in your estate planning documents directions that all, or a portion, of your estate is to be left to a QTIP trust. An alternative would be to acquire cash value life insurance on your life with a QTIP trust named as the beneficiary. This would provide flexibility by allowing you to have access to policy cash values via withdrawals or policy loans during your life, while funding a QTIP trust with death benefits when you pass away.
- When combined with a properly designed and competitive cash value life insurance policy, this strategy provides financial security for a spouse while ensuring those you care for most will benefit from the wealth you have accumulated over a lifetime.
- When the cash value life insurance policy is owned personally, the owner retains access to cash values that may be used for lifetime financial needs.
- When the trust is properly designed and a proper QTIP election is made, the initial transfer to the QTIP trust will qualify for the unlimited spousal exemption, thereby avoiding gift and estate taxes when transferred.
- The remaining balance in a QTIP trust is subject to estate taxes at the death of the surviving spouse; however, the remainder beneficiaries will receive a step-up in basis on property distributed from the trust. In other words, capital gain property distributed to the remainder beneficiaries may be sold for little to no capital gains tax.
- With a special election called a Clayton election, the decision as to how to allocate your estate may be deferred until your death. This provides an opportunity to make a more efficient allocation based on tax laws and family dynamics at the time.
More Options for Flexibility
This paper is not intended to be exhaustive by any means. Other techniques can be very helpful in certain circumstances, such as the use of Private Financing (avoids the need for making gifts to a trust for the purpose of funding premium payments) and Private Split-Dollar, which combines the benefits of a typical ILIT with a greater level of flexibility.
We are here to help you choose the right estate planning strategy for your family. Give us a call at 888-827-0146 to schedule an appointment and get started.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the managing partner of Suncrest Advisors, he, his partner, and their associates all aim to provide financial security and peace of mind to business owners, executives and professionals, and high net-worth individuals across the United States. Along with more than four decades of experience, Boyce is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit https://suncrestadvisors.com/ or connect with Boyce on LinkedIn.