Family gifting strategies

After your client builds wealth and reaches a place of financial security, they are now in a position to begin sharing wealth with their loved ones. Lifetime gifting is a powerful estate planning technique that enables them to enjoy seeing loved ones benefit from their legacy during their lifetime.

How does family gifting work?

Under IRS guidelines, your client can give up to the annual gift tax exclusion amount ($18,000 in 2024) every year to any number of recipients, free of gift tax. Married couples can apply both of their exclusion amounts to a single gift − effectively doubling the exclusion amount − provided they both consent and properly file a timely gift tax return.

Magnify your client’s gift

Your client can leverage their annual gifts through the use of permanent life insurance. In addition to death benefit protection, permanent life insurance provides long-term, tax-deferred accumulation that is accessible through policy loans. Several options are available:

Purchase life insurance for their child, protecting their family and supplementing their retirement income.
Purchase life insurance for their grandchild, providing an education fund and eventually a cash accumulation fund.
Purchase trust-owned life insurance on themselves, naming the trust as beneficiary.

Buying life insurance for children and grandchildren: Who should own the policy?

Parents of the Insured: Parents have total control over the policy and can manage until child is a responsible age. Gift taxes may apply when transferring ownership later.

Trust: A trust offers flexibility and control but involves legal fees to create and possible ongoing administration costs. Of all the options listed, a trust typically offers the most sophisticated planning and protection.

Child/insured: Generally, a minor child is not competent to own a life insurance policy. However, your client could set up a custodianship where an adult will manage the policy on behalf of the child until the child reaches adulthood (typically age 18, 21 or 25, depending on state law).

Grandparents of the insured: Grandparents have total control over policy but receive no current gift or estate tax benefits. Consider naming a successor owner to avoid probate.

The benefits

When the time is right, parents or grandparents who own a policy on the child/insured’s life could gift the policy to the insured by submitting a change of ownership request. This allows the insured to personally own the policy. Your client should consult their tax advisor, as gift taxes may apply at the time of the transfer.
By purchasing life insurance, your client can magnify annual gifts made to their heirs. In addition to death benefit protection, permanent life insurance provides long term, tax-deferred accumulation that is accessible through policy loans.
Assets given away often pass outside of probate, simplifying the administration process for their heirs.
Lifetime gifts can also provide estate tax savings by removing the asset and its future appreciation from their taxable estate.

Additional considerations

Be careful of unintended tax consequences as your clients select a beneficiary when a contract owner is different from the insured. Consult with your client’s tax advisor for further guidance.
If the insured is a minor, a parent must sign the application and there must be at least twice as much life insurance on the parents’ lives as there will be on the minor child. There should be at least a 2-to-1 ratio, parents to child.
As a general rule, if your client is concerned about a beneficiary’s ability to manage money or their potential divorce, a trust is often the preferred vehicle for life insurance.
As with any legal documents, your client should work with an attorney to recommend and draft trust documents and to assist with any ongoing trust formalities.

This material provides general information that is designed to be educational in nature and is not intended as specific tax or legal advice to any particular individual nor the law of any particular state. Please seek the advice of a qualified tax or legal professional for your client’s specific situation.

If tax-free loans are taken and the policy lapses, a taxable event may occur. Withdrawals (partial surrenders) and loans from life insurance policies classified as modified endowment contracts may be subject to tax at the time the withdrawal or loan is taken and, if taken prior to age 59½, an additional 10% federal tax may apply. Withdrawals and loans reduce the death benefit and cash surrender value.

Products are issued by the AuguStar Life Insurance Company, member of Constellation Insurance, Inc. family of companies. Product, product features and rider availability vary by state. Guarantees are based upon the claims-paying ability of the issuer. Issuer not licensed to conduct business in New York.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2533-FP-Web Rev. 03-25

Cross-purchase buy-sell agreement

After your client invests significant time, sweat and resources into their business, it is important to have a plan to harvest the return on that investment and to successfully transition ownership. As they plan to transition their business in the future, they can use a buy-sell agreement to determine the purchase price, the funding source, and what will initiate the agreement. A buy-sell helps ensure your client and their family will receive the full and fair value for their share.

One of the most common types of buy-sell agreements is a cross-purchase. In a cross-purchase buy-sell, your client and the other business owner(s) agree to buy the business interests of an owner who dies, becomes disabled, retires, or otherwise leaves the business.

How it works

Your client and the other business owner(s) draft an agreement for an orderly transfer of the business following a triggering event such as death, disability, or retirement of an owner. The plan outlines how the interests/shares of the departing owner(s) will be purchased by the remaining owner(s). In turn, the departing owner (or his/her estate) agrees to transfer his/her interests to the other owner(s) for the agreed upon price when the triggering event occurs. The remaining owner(s) will end up with the entire business and the departing owner’s family will receive the pre-determined price in exchange.

Funding with life insurance

Life insurance is an ideal funding source because it is often the most affordable option when compared to other choices such as a bank loan, sinking fund, or installment sale. Life insurance proceeds are income tax-free providing liquidity exactly when it may be needed most. Additionally, permanent life insurance can accumulate cash value to help fund a buyout upon disability or retirement.

With a cross-purchase, your client and each business owner purchase an insurance policy on the life of each other and are the beneficiary of the policy. Each owner pays the premiums on each policy that he/she owns. Upon disability or death of a business owner, proceeds from the disability or life insurance policy pass to the surviving business owner(s) who use the proceeds to purchase the business interest from the departing owner.

The benefits

Surviving owners receive an increased cost basis (the original value of an asset for tax purposes) in the acquired business interest which may reduce any future taxable gain.
Life insurance does not increase the buyout price because the business does not own the policies.
A buy-sell agreement can create a degree of stability that may be important to creditors, suppliers, employees, and their families.
Your client and the other owner(s) can agree how the purchase price and terms will be determined no, rather than waiting until death or disability which could potentially reduce the value of the business.
Business succession planning combined with the guarantees of life insurance can help provide your client with peace of mind.
For a two-owner business, due to its simplicity and tax advantages, the cross-purchase is the most common type of agreement. It requires only one insurance policy per owner and the remaining owner receives an increased cost-basis after purchase.

Additional considerations

While the “swap” powers give flexibility, the trust document is typically irrevocable and cannot be changed except as the trust itself allows.
Cross-purchase agreements generally work best when there are three or fewer business owners. Otherwise, the agreement can become administratively complicated.
The number of policies needed is the number of owners multiplied by the number of owners minus one. For example, a three-owner business would generally require a total of six insurance policies to fund the agreement.
If a significant age or health disparity exists among owners, the younger or healthier owners will pay higher premium payments on the policies insuring the older or less healthy owners.
Life insurance premiums paid are generally not tax deductible to the individual owners.
Upon the death of an owner, his/her estate will own policies on the other owners. If the other owners purchase the policies from the deceased owner’s estate, the purchase may be subject to special tax rules.
A fringe benefit plan such as a bonus or a split-dollar arrangement may be possible to help defray the buyer’s personal cost of the life insurance policy (for C-Corporation owners). To learn more, talk to your financial professional.
Work closely with a business planning attorney to design and create a buy-sell agreement that works best for your client.

If tax-free loans are taken and the policy lapses, a taxable event may occur. Withdrawals (partial surrenders) and loans from life insurance policies classified as modified endowment contracts may be subject to tax at the time the withdrawal or loan is taken and, if taken prior to age 59 1/2, an additional 10% federal tax may apply. Withdrawals and loans reduce the death benefit and cash surrender value.

Products issued by AuguStar Life Insurance Company, member of Constellation Insurance, Inc. family of companies. Product, product features, and rider availability vary by state. Guarantees are based on the claims-paying ability of the issuer. Issuer not licensed to do business in New York.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2313-FP-Web Rev. 03-25

Taxation of deferred annuities

The taxation of deferred annuities has been changed so often that a single annuity contract could be subject to multiple tax rules depending upon the timing of the investments in the contract. A chronological list of the various rules that apply to annuities will be used to help understand the complexity of the taxation of annuities and, in particular, the taxation of distributions prior to the annuity starting date. In most cases, the applicability of a rule or set of rules depends on the date of the contribution to the annuity contract.

Investments prior to Aug. 14, 1982

For amounts allocable to investments in annuities prior to Aug. 14, 1982, any withdrawal from the contract which is not an annuity payment is treated as a return on the investment in the contract, first, and taxable as ordinary income only after the investment has been completely withdrawn. The owner could also take a loan against the cash value of the contract and the loan would not be treated as a withdrawal. No income tax penalties are imposed on premature distributions.

Investments between Aug. 14, 1982 and Jan. 18, 1985

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) modified the taxation of distributions from annuity contracts by replacing the first-in, first-out (FIFO) rule, which allowed tax-free distributions of periodic payments up to the amount of the investment in the contract, with a last-in, first-out (LIFO) rule which treats any periodic withdrawal as a distribution of earnings first and then a return of the investment in the contract only after all the earnings have been withdrawn.

TEFRA also required that loans be treated as distributions subject to LIFO treatment for investments made on or after Aug. 14, 1982. Immediate annuities were not affected by these tax law changes.

In addition to reversing the status of periodic withdrawals from annuity contracts, TEFRA also imposed a 5% penalty on the taxable portion of any distribution from an annuity except for distributions:

made on or after the taxpayer attains age 59 ½,
made on account of death or disability of the taxpayer,
which are part of a series of substantially equal periodic payments made for the life of the taxpayer or over a period extending for at least 60 months after the annuity starting date,
made from a qualified plan, or
allocable to investments made in the contract prior to Aug. 14, 1982.

Investments in contracts Issued after Jan. 18, 1985

Under TEFRA, the 5% penalty was applicable only to taxable amounts allocable to investments in the annuity contract made during the 10-year period immediately preceding the date of the distribution. Because of the complexity of tracing amounts allocable to investments made within 10 years prior to a particular withdrawal, the 10-yearaging provision was repealed by the Tax Reform Act of 1984. The repeal is effective for contracts issued after Jan. 18, 1985. Therefore, for any contracts issued prior to Jan. 19, 1985, premature distributions allocable to investments in the contract made after Aug. 13, 1982, are subject to a penalty if the 10-year aging is not satisfied. Premature distributions from contracts issued after Jan. 18, 1985, are subject to the penalty regardless of how much time has elapsed since the investment in the contract, unless one of the exceptions is satisfied.

Investments in contracts after Feb. 28, 1986

Annuity contracts which are owned by corporations and other non-natural entities are taxed according to the provisions of Internal Revenue Code Section 72(u). This code section states that gain on such an annuity contract is treated as ordinary income in the year it is credited to the contract. In other words, the inside build-up, or gain, is not deferred each year, but is subject to income taxes each year as it is earned. The change in the tax law affects annuities issued after Feb. 28, 1986, or contributions into existing annuity contracts which are made after the 1986 effective date.

There are several exceptions to the income tax treatment of annuities held by non-natural entities. The rule does not apply to any annuity contract which is:

acquired by the estate of a decedent by reason of the death of the decedent,
held under a qualified pension, profit sharing, or stock bonus plan, as a 403(b) tax-sheltered annuity, or under an individual retirement plan,
a qualified funding asset (as defined in Section 130(d), but without regard to whether there is a qualified assignment,
purchased by an employer upon the termination of a qualified plan and held by the employer until all amounts under the contract are distributed to the employee for whom the contract was purchased or the employee’s beneficiary, or
an immediate annuity.

The tax code specifically states that if an annuity is held by a trust or other entity as an agent for a natural person, then the annuity is considered to be held by a natural person. As such, the inside build-up of gain will not be subject to tax each year. What the Code doesn’t clearly explain is what is meant by holding an annuity as an agent for a natural person. While there are several Private Letter Rulings indicating the IRS thinking on the matter, those only apply to the particular case. There are no regulations or authoritative rulings on what constitutes “an agent for a natural person.”

Trust ownership

The uncertainty in this area typically arises when irrevocable trusts own annuity contracts. The resolution of this issue depends on what type of trust you are dealing with in a particular situation.

There is very little authority in the form of regulations or rulings covering this subject. The few Private Letter Rulings that have been published seem to take a rather strict and literal reading of the code section. The critical issue boils down to whether the annuity contract is traceable to a single beneficiary to use for his/her retirement. If a trust has only one beneficiary, then the trust is merely a nominal owner and the individual is the beneficial owner of the contract. If the individual is considered to be the beneficial owner of the annuity contact, then the rules of Section 72(u) do not apply. Examples of this type of trust situation would include revocable living trusts and grantor trusts.

Where there are multiple trust beneficiaries, but only one annuity contract owned by the trust, it appears that the contract is being pooled for the use of multiple beneficiaries. This is problematic because the purpose behind the gain deferral is that the annuity is only available for a single person’s retirement.

Corporate ownership

The rules of Section 72(u) also apply to annuities owned by corporations. The most common issue surrounds the tax treatment of annuities owned by a corporation as part of a deferred compensation plan. Deferred compensation plans require the corporation to own the funding vehicle, and as such, the corporate annuity would be subject to the rules of Section 72(u). Since a corporate-owned annuity would be taxed on any gain each year, the tax consequences make it more expensive to use an annuity as the funding vehicle in a deferred compensation plan.

Contracts issued after April 22, 1987

The Tax Reform act of 1986 also modified the rule regarding the income tax treatment of gratuitous transfers of annuity contracts. Under prior law, the gift of an annuity contract did not result in recognition of gain. However, the Service had taken the position that if the donee subsequently surrenders the contract, the donor must recognize gain to the extent of any gain in the contract at the time of the gift. If a contract issued after April 22, 1987, is transferred for less than full and adequate consideration, the transferor is treated as receiving an amount equal to the gain in the contract as an amount not received as an annuity, meaning that the taxation on gain is not deferred. That amount would be included as ordinary income and would be subject to the penalty if it is a premature distribution. This rule does not apply to transfers between spouses.

The recipient of the contract would increase his/her other investment in the contract by the amount included in the transferor’s income so that the investment in the contract for purposes of determining gain would normally equal the cash value of the contract at the time of transfer.

Penalty on premature distributions

The penalty on premature distributions is 10%. This rate is applicable to any distributions made after De. 31, 1986, which are subject to the penalty. Distributions allocable to investment in contracts before Aug. 14, 1982, are not subject to the penalty.

Order of distributions

Because of the number of different rules which could apply to a single annuity contract, it is necessary to understand the order in which amounts subject to the various rules can be withdrawn. Periodic withdrawals from annuities held by individuals are categorized in the following order:

investments made before Aug. 14, 1982;
gain attributable to investments made before Aug. 14, 1982;
gain attributable to investments made on or after Aug. 14, 1982, and before Jan. 19, 1985 (subject to a 10% penalty on premature distributions attributable to such investments made within the 10-year period prior to the distribution);
gain attributable to investments made on or after Jan. 19, 1985 (10% penalty tax on premature distributions attributable to such investments); and
investments made on or after Aug. 14, 1982.

Distributions from annuity contracts held by someone other than a natural person are categorized in the following order:

investments made before Aug. 14, 1982;
gain attributable to investments made before Aug. 14, 1982;
gain attributable to investments made on or after Aug. 14, 1982, and before Jan. 1985 (subject to a 10% penalty on premature distributions attributable to such investments made within the 10-year period prior to the distribution);
gain attributable to investments made on or after Jan. 19, 1985, and before Feb. 28, 1986 (subject to a 10% penalty tax on premature distributions attributable to such investments);
investments made on or after Aug. 14, 1982, and before Feb. 28, 1986; and
gain attributable to investments made on or after Feb. 28, 1986 (no part of the distribution would be subject to tax because the income on the contract would have already been taxed).

Section 1035 exhanges

Under Section 1035 of Internal Revenue Code, an annuity contract may be exchanged for another annuity on a tax-free basis. In order to obtain this tax treatment, certain conditions must be satisfied. The regulations provide that in order to avoid gain or loss on the transaction, the same person or persons must be the obligee or obligees under the contract received in the exchange as under the original contract.

An important issue regarding Section 1035 exchanges is the income tax treatment of distributions from the contract received in the exchange. As we have seen, the taxation of the distribution varies depending on the date of the contract or the date of the contribution. The most favorable treatment is afforded amounts attributable to contributions made prior to Aug. 14, 1982. The Committee Report states that “a replacement contract obtained in a tax-free exchange of contracts succeeds to the status of the surrendered contract for purposes of the new provisions”. The Service affirmed this result in Revenue Ruling 85-159, 1985-2 CB 29. Consequently, when a pre-Aug. 14, 1982, contract is exchanged for another contract, the new contract is taxed in the same manner as the original one would have been. Periodic withdrawals are treated as return on investment first and there is no penalty on premature withdrawals.

Conclusion

The taxation of annuities has gone through many changes. The result is a labyrinth of rules when the same contract includes contributions which span the period of changes. Perhaps the best approach for avoiding this complexity is to keep contributions from different phases in this evolution segregated in separate contracts. For those contract owners who have already mixed contributions subject to different tax rules in one contract, a very careful and thorough analysis is necessary before they can be accurately advised about the tax consequences of transactions with their policies.

This material provides general information designed to be educational in nature and is not intended as specific tax or legal advice to any particular individual nor the law of any particular state. Tax laws and applicable legal requirements are subject to change. Clients should consult with a qualified tax or legal professional regarding their specific situation.

FOR FINANCIAL REPRESENTATIVE USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC.

590164FMA-Web 03-25

Simplifying RMDs using annuities

This is a condensed guide of Required Minimum Distribution (RMD) rules and how annuities can help simplify the RMD process.

An RMD is money that must be withdrawn from a retirement savings plan each year once the account holder reaches a certain age. If your client owns a qualified account such as a traditional IRA or 401(k), once they turn 73, the deadline to take their first RMD is April 1 of the following year, with some exceptions for 401(k) accounts. And subsequent RMDs must be taken by Dec. 31. Starting in 2033, the RMD age will increase to 75.

Remember to aggregate accounts of the same type to determine your client’s total RMD. Also note that they may satisfy RMDs by taking a distribution from any number of their accounts of the same type. Failing to take RMDs on time will generally result in considerable penalties. Although the IRS has waived penalties for missed RMDs on inherited accounts through 2024, there is no expectation that it will continue to do so in 2025 or thereafter.

Annuities and consolidating RMDs

Consider using an Income Annuity to help satisfy your client’s RMDs. At age 73, their RMD will be less than 4% of all their qualified accounts’ values, under current RMD regulation. For example, say your client has three traditional IRAs, each with a $100,000 year-end value. That means their first RMD for the aggregate accounts is $11,320. Now consider using two of their IRAs to purchase an AuguStar Orbiter annuity with an income rider¹ paying 7.1% (single option) at age 73. That will equal more than $14,000 of income in the first year of distributions, more than satisfying the RMD for not only the two IRAs moved into the annuity, but also the RMD for the third account left outside of the annuity. This avoids disrupting the growth of that last IRA. Finally, the AuguStar rider increases income on a yearly basis, which helps keep pace with potentially growing RMDs.

Inherited accounts

For inherited qualified accounts, the RMD rules depend on the designation of the beneficiary. Eligible designated beneficiaries (EDB) include minor children, individuals with disability or chronic illness, any other individual who is not more than 10 years younger than the original account holder, and spouses.

EDBs have the advantage of a stretch option, allowing them to withdraw the account balance over their life expectancy. Although, minor children must switch over to the ‘out in 10’ rule once they reach age of majority. Spouses have additional options. For example, a surviving spouse can uniquely elect to roll over the inherited assets into an existing or new IRA in their own name. Alternatively, a surviving spouse can transfer assets to an inherited IRA, with the added benefit of accessing the asset even if they’re younger than 59½.

Finally, non-EDBs must empty the inherited qualified account balance within 10 years of the original owner’s death. If RMDs had not kicked in for the original owner, there are no mandatory distributions until the end of the 10-year period. If RMDs had kicked in, the beneficiary will have to continue taking RMDs each year based on their own life expectancy (if younger than the decedent), while still adhering to the ‘out in 10’ rule. As mentioned, penalties for missed RMDs on inherited accounts have been waived in prior years but will likely not be waived in 2025 or thereafter.

¹ Charge for the rider is 1.15% for single or joint rider option. The annual cost can increase on any rider anniversary after the second up to a maximum of 2.5%. Your client may decline a cost increase, but doing so could reduce the MAW percentage associated with their rider.

Products issued by AuguStar Life Insurance Company. Product, product features and rider availability vary by state. Issuers not licensed to conduct business in New York. Guarantees are based upon the claims-paying ability of the issuer.

Fixed indexed annuities (“FIA”) are long-term investment vehicles designed to accumulate money on a tax-deferred basis for retirement purposes. Upon retirement, FIAs may provide an income stream or a lump sum. If your dies during the accumulation or payout phase, their beneficiary may be eligible to receive any remaining Contract Value.

A FIA is not a registered security or stock market investment and does not allow direct participation in any stock or equity investments, or index. The index used is a price index and tracks market performance and does not reflect dividends paid on the underlying stocks. Indices are typically unmanaged and are not available for direct investment.

This web page provides general information that should not be construed as specific legal advice nor the law of any particular state.

Clients should seek the advice of a qualified tax advisor or attorney for their specific situation.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

10180FMP-FP-Web 03-25

Revocable living trusts

A revocable living trust is a dynamic estate planning tool for holding assets during lifetime and at death. A trust exists when one person (often called the grantor or settlor) gives property to another person (called the trustee) to hold and manage for one or more other persons (called the beneficiaries).

Your client may wish to create a revocable living trust in order to avoid probate or to provide estate management for their family after your client’s death. When paired with life insurance, a trust can provide a powerful legacy plan for your client and their heirs.

How does it work?

Your client’s attorney drafts the trust to meet their individual goals. As a “revocable” trust, your client can typically modify or even cancel it during their lifetime. In most cases, your client − the trust creator − will act as the trustee during their lifetime. Should your client become incapacitated or unable to act, your client’s successor trustee steps in to manage trust assets according to the trust document. Once the trust is established, your client’s attorney will instruct them on how to “fund” the trust. This might involve steps like retitling assets in the name of the trust or updating beneficiary designations.

Revocable living trusts and life insurance

Life insurance fits well with many revocable living trusts. For example, your client might have beneficiaries who would be unable to manage a large inheritance due to young age or lack of capacity. Life insurance policy proceeds can be paid directly to the trust. Once in the trust, the assets will be managed and/or distributed according to your client’s instructions. Your client’s trust can be designed to distribute funds for things like health, education, maintenance and support of the beneficiary without distributing a large sum all at once.

Additionally, life insurance death benefits are income tax free with very few exceptions, and the trust can be structured to stretch distributions over any period of time, including the lifetime of a beneficiary. This can be an effective legacy planning tool for many situations.

The benefits

When properly structured, assets inside a revocable living trust avoid the costs, delays, and publicity of probate at death.
Because trust assets pass outside of probate, your client’s trust agreement can be kept private in most cases.
Revocable trusts offer incapacity planning. If your client was to become incapacitated, their successor trustee can manage trust assets on your client’s behalf.
A revocable living trust can be useful if your client has a complex estate or if your client owns real estate in several states.
Your client’s trust can be drafted with “spendthrift” language and discretionary distributions to protect beneficiaries who might get divorced or who otherwise have creditor protection or spending issues of their own.

Additional considerations

Revocable living trusts are relatively more expensive than a simple will.
As with all estate planning documents, your client should work with an attorney to draft their trust and to explain the funding process (updating beneficiary designations, retitling accounts, etc.). In some situations, your client’s attorney might even recommend leaving your client’s trust “unfunded” until death.
Assets inside a revocable living trust are generally included in your client’s taxable estate for estate tax purposes. If your client has a taxable estate, additional estate planning may be recommended.
Because your client can revoke the trust during their lifetime, revocable living trusts typically do not offer creditor protection against their own creditors.
Some assets − such as Individual Retirement Accounts (IRAs) − cannot be owned by a revocable living trust during your client’s lifetime.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2314-FP-Web Rev. 03-25

Spousal Lifetime Access Trusts

The Tax Cuts and Jobs Act of 2017 may provide an unprecedented opportunity for your client to make tax-free wealth transfers to their beneficiaries. An increased lifetime exclusion amount for estate and gift tax purposes ($13.61 million/person in 2024 or $27.22 million/married couple, as indexed for inflation) may enable individuals to transfer significant amounts of wealth − tax-free. And if your client already exhausted their lifetime gifting exemption with prior planning, their gifting capacity may have been significantly increased.

A common strategy to help combat estate taxes is to establish an ILIT, an Irrevocable Life Insurance Trust, but many people worry that an ILIT also denies access to the life insurance policy’s cash value while the insured is alive. A powerful strategy that helps manage the accessibility concern is establishing a Spousal Lifetime Access Trust − commonly called a SLAT.

What is a Spousal Lifetime Access Trust?

A SLAT is a special type of irrevocable life insurance trust that includes provisions allowing the non-grantor spouse access to the policy. The spouse that establishes the trust, the grantor, creates more flexibility than an ILIT by unlocking the life insurance policy’s cash value for the non-grantor spouse’s lifetime needs. And, with a SLAT, the life insurance death benefit is still excluded from the grantor’s estate.

How does it work?

A married individual establishes a SLAT. The trust grantor gifts amounts to the trust which, in turn, pays the premiums on a permanent life insurance policy on the life of the grantor. A trustee is named and he/she is allowed to make distributions of the policy’s accumulated cash value for the health, education, maintenance and support of the non-grantor spouse, as outlined in the trust. The policy and its corresponding values would not be included in either spouse’s estate for estate tax purposes.

This makes the SLAT a powerful estate planning tool that balances the power of cash value life insurance with estate tax planning.

The benefits

Assets gifted to the SLAT are no longer included in grantor’s estate for estate tax purposes.
Unlike a traditional ILIT, the life insurance cash value is accessible for the health, education, maintenance, and support of the non-grantor spouse, as outlined in the trust.
When the grantor dies, the trust assets are enhanced by the income tax-free death benefit of the life insurance policy, thereby leveraging the original gift(s) to the trust.
Although a SLAT can own almost any asset, life insurance works well due to its tax-deferred cash value accumulation and significant death benefit potential.

Additional considerations

This strategy requires the services of a skilled attorney who can draft the trust document(s) in strict adherence to current tax laws.
The trust creator (grantor) cannot have direct access to the cash value of the policy in the trust. Direct access will likely result in trust assets being included in the grantor’s estate for estate tax purposes.
The couple may consider having two SLATs − one for each spouse. Couples interested in having a SLAT for each spouse must avoid “mirror trusts.” Your client should discuss options with their attorney to ensure proper structure.
Distributions to the non-grantor spouse should generally be limited to satisfying health, education, maintenance, and support needs, as outlined in the trust.
Many SLATs are structured such that divorce or death of the non-grantor spouse ends all spousal access to cash values. Generally, many trusts will include language for successor beneficiaries in both situations.

If tax-free loans are taken and the policy lapses, a taxable event may occur. Withdrawals (partial surrenders) and loans from life insurance policies classified as modified endowment contracts may be subject to tax at the time the withdrawal or loan is taken and if taken prior to age 59½, an additional 10% federal tax may apply. Withdrawals and loans reduce the death benefit and cash surrender value.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2292-FP-Web 03-25

Key person life insurance

Your clients know that their employees help make their business a successful, thriving enterprise. In fact, they may identify some employees as “key” to the organization’s ongoing success. These individuals possess unique skills, expertise, decision-making power and vision. Key person life insurance is an important protection strategy.

What is key person life insurance?

Key person insurance is a life insurance policy purchased by, owned by and payable to a business. A key person life insurance policy protects against business losses as a result of the death of a key person. When permanent life insurance is used, the business can access accumulated cash values in the policy as a source of capital to offset business expenses, take advantage of expansion opportunities, or to create fringe benefits for key employees.

If the insured employee passes away, the policy’s death benefit provides capital to help the company continue. Unlike other sources of capital – such as a sinking fund, a loan, or company earnings – life insurance provides liquidity precisely when the need arises: upon the death of a key person. Further, disability riders are available that can waive premium payments in the event of the insured’s qualifying disability.

How key person life insurance protects your client’s company

Your client’s business pays the life insurance policy premiums and is typically the owner and beneficiary of the policy. As owner of the policy, the business may access cash values, typically via loans, during the key person’s lifetime. When the key person dies, life insurance proceeds, minus any loan amounts, are paid to the business and can be used to offset losses. Alternatively, upon the key person’s retirement, the company may decide to sell or bonus the policy to the insured, surrender the policy or simply keep it in force.

The benefits

The business can receive an income tax-free death benefit upon death of the key person, thereby providing liquidity precisely when the need arises.
When permanent life insurance is used, the business (as owner of the policy) has access to cash values during the life of the insured.
Accumulated cash values in permanent life insurance can be used as a source of capital for business expenses, to create fringe benefits, and/or provide a rainy-day fund for the business.
Optional disability riders are available that waive premiums in the event of the insured’s total disability.
Accumulated earnings tax will not accrue if life insurance is purchased to reasonably compensate the business for a loss.

Additional considerations

The employee should be a key person in the business. This includes directors, executives, or employees with unique skills and talents.
To help ensure that death benefits are received income tax-free, the business must obtain notice and consent from the insured employee, prior to issuance of the policy.
The company should adopt a board resolution authorizing the policy and documenting the need for key person protection.
Premiums paid for key person life insurance are not a deductible business expense.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2530-FP-Web Rev. 03-25

Irrevocable life insurance trusts

Introduction

The irrevocable life insurance trust is probably the most significant insurance-related estate planning tool available to your clients. The irrevocable nature of the trust can provide estate tax savings while the insurance connection provides a cost-effective way to pay estate taxes.

The appeal of an irrevocable life insurance trust is that the death proceeds of the policy are not included in the insured’s estate. If kept out of the decedent’s estate, the death proceeds will not increase the estate tax burden. The irrevocable life insurance trust is a double winner because, not only are the death proceeds outside the insured’s estate, but the proceeds can be available to meet estate liquidity needs.

An irrevocable life insurance trust can be created by irrevocably transferring ownership of a policy to the trust or by having the trust, through its trustee, acquire a life insurance policy owned by the trust.

To ensure that the life insurance proceeds will be excluded from the insured’s estate, the following requirements must be met:

The insured must not have any incidents of ownership in the policy.
The trust must be irrevocable.
The insured(s) should not be the trustee of the trust.
The insured should have no beneficial interest or retained power.
The insured must survive for at least three years from the date of any policy transfer into the trust; otherwise, the insurance proceeds will be included in the insured’s gross estate.
The trust document should not require or encourage the trustee to use life insurance proceeds to pay the insured’s estate taxes.

The following are some factors for consideration when deciding whether to adopt an irrevocable life insurance trust.

Greater flexibility in handling distributions of the proceeds and income as compared to insurance settlement options. Contingencies such as divorce, remarriage, children of a second marriage and other events may be anticipated and provided for. Restrictions and limitations on the use of the funds for the beneficiaries may be included in the trust.
The trustee should be authorized and empowered (but no directed) to lend trust principal to the grantor’s executors or to the executors of the grantor’s spouse or to purchase assets belonging to either of their estates. If this provision is included in the trust, life insurance can accomplish one of its most useful roles ─ providing liquidity to an estate and helping its executors to avoid forced sales of estate assets to meet the burden of taxes and administration expenses.
The insured should never be a trustee of the irrevocable life insurance trust. The insured should assign all rights to the policy to avoid retaining any incidents of ownership.
Trust beneficiaries may be give a demand right in the trust to take advantage of the annual exclusion for gifts of a present interest. Thought must be given to the notice provision and to the financing of any withdrawal rights so that Crummey powers will not be deemed illusory.
All policies in the trust should be described accurately, and the description should include the policy number, the name of the carrier, the face amount of the policy, and the name of the insured. The purchase of additional policies should be provided for, if desired.
Provisions must be included to enable the grantor’s estate to obtain a marital deduction if the grantor of the trust dies within three years of the date on which the policies became part of the trust. The trust instrument should provide that the life insurance proceeds payable at the death of the grantor be paid to the grantor’s spouse or to a trust that is established for the spouse’s benefit and will qualify for the estate tax marital deduction.

How it works

There are two typical methods of acquiring life insurance in an irrevocable life insurance trust. The first is the transfer by the insured by gift of a policy on the insured’s life to the trustee of the trust. The second is to have the trusteee purchase the policy directly from the insurance company for the ultimate benefit of the named beneficiaries of the trust.

Assuming that you are starting from scratch, the trust document should be drafted by the client’s attorney early in the process so that the trust, through its trustee, can be the applicant, owner and beneficiary of the policy from the start. In effect, this procedure will eliminate three-year-rule concerns, which will be discussed later.

It is not always possible to get things moving fast enough with the client’s attorney. When your clients allow you to revie their estate and agree that life insurance is the best solution, the insurance becomes the first step. Plans may call for an irrevocable trust to own the policy, but real life says that it may be months until the trust is actually drafted and signed by the client(s). So, the main objective is to get the life insurance in force. It would certainly be much better to have the life insurance in force and included in the insured’s gross estate than to have the client die without life insurance while waiting for a trust to be drafted. Here are two options you may discuss with your client:

Option 1: Submit a cover letter with the application indicating AuguStar should “hold to issue” the policy until the trust has been drafted. This will avoid the three-year rule but creates a period of risk until the policy is in force. This should only be considered if the trust is drafted shortly after the life application is submitted.
Option 2: Take the steps to put the life insurance in force, and the policyowner may later gift the policy to the trust by completing an ownership (and beneficiary) change. This implicates the three-year rule, but the client may decide it is better to have the life insurance in force and included in the estate than to die without coverage while waiting on the trust.

Now the trustee is the owner and beneficiary of the policy and will pay future premium payments when due. The insured will make cash contributions to the trustee on a periodic basis to provide premium payment dollars.

At the time of the client’s death, the life insurance death benefit is paid to the trustee. The provisions of the trust give the trustee the discretion to purchase assets from or loan money to the estate of the decedent. This is the technique used to get cash from the trust to the personal representative of the estate to pay estate settlement costs.

The three-year rule

It is important to remember that the transfer of a life insurance policy can trigger the three-year rule. The three-year rule applies to transfers of a policy within three years of death, whether transferred outright or to an irrevocable trust. Therefore, any transfer of a policy made within three years of death will automatically be included in the decedent’s estate.

If the transfer occurred at least three years before the insured’s death, the fact that the insured paid the premiums will not cause the death proceeds to be included in the decedent’s estate. In 1987 case, Estate of Leder, stated that no estate tax inclusion will result even in the decedent paid premiums within three years of death, as long as the decedent had no ownership rights in the policy. The key question is whether or not the decedent had any incidents of ownership in the policy, not whether the decedent paid premiums for a previously owned policy.

If the client dies within three years of the policy transfer, the face amount of the insurance would be included in the decedent’s gross estate. While this is not desirable, the client is still better off for having additional funds available, even if they are taxed.

One suggested provision to include in the trust would provide that if death occurred within three years of the transfer and the IRS determined that the proceeds were included in the insured’s gross estate, the trustee would be directed to immediately pay out the proceeds to the spouse of the decedent. In this way the proceeds would qualify for the marital deduction eliminating any federal estate tax on the proceeds.

Crummey withdrawal powers

In addition to estate tax advantages, there are gift tax advantages when an irrevocable life insurance trust is used. The combination of an irrevocable trust and Crummey withdrawal powers results in a tax-advantaged estate planning tool.

A gift, in order to qualify for the annual gift tax exclusion, must be a gift of present interest in property, where the donee can immediately enjoy the property or its income. If the gift is of a future interest in property (a property right that is valid today but use or enjoyment is postponed until sometime in the future), then no exclusion is allowed. Transfers to irrevocable trusts technically fall into the future interest category, but qualification as a present interest can be obtained if a beneficiary has the right to withdraw or demand trust income.

The annual gift tax exclusion is currently $18,000 in 2024 (as indexed for inflation; $36,000 if gift-splitting is issued by a married couple) per donee per year. The most common technique for qualifying trust contributions for the annual exclusion is the Crummey demand power (named after the case establishing the power). This power grants the beneficiary the right to demand limited amounts of principal or income, is non-cumulative and lapses if not exercised withing a stated period of time. The intent is that no withdrawals will be made and that the money will be available for the trustee to use for premium payments.

A Crummey power inserted in a trust allows the beneficiary to withdraw any or all of the donor’s annual contribution to the trust. Because the beneficiary, in exercising the demand power, could pass trust funds to himself or herself, the power is deemed a general power of appointment under I.R.C. Section 2514(c). This Code section treats the release of a general power of appointment as a transfer of property to a trust co-beneficiary if there is more than one beneficiary of the trust, and such transfer is subject to gift tax. If the power is not exercised and lapses, the tax code treats this as a taxable-gift-over to the trust beneficiaries by the one beneficiary, but only to the extent that the lapse exceeds the greater of $5,000 or 5% of the total value of the assets subject tot he power. This limitation of $5,000 or 5% is commonly known as the five-and-five power.

The IRS issued a Private Letter Ruling (PLR 8727003) which restricts the use of Crummey withdrawal powers in some situations. While a Private Letter Ruling is not a binding pronouncement, it can be a sign of things to come. A typical Crummey withdrawal power gives a trust beneficiary a non-cumulative power to withdraw a specified amount of trust corpus. In PLR 8727003, the IRS disallowed the annual gift tax exclusion for transfers where the withdrawal powers were held by persons who did not have a vested interest in the trust. In other words, the IRS held that the gift tax annual exclusion is available only for transfers where the powerholders are vested trust beneficiaries or beneficiaries who have actually exercised their withdrawal rights.

It is necessary to use care in designing Crummey powers. Beneficiaries should be given a substantial interest in the trust because only a remote contingent interest in a remainder of a trust may not be enough to qualify for the annual gift tax exclusion. The IRS is concerned when additional beneficiaries are named in the trust (typically minor grandchildren of the donor) in an effort to avoid federal gift tax through proliferation of annual exclusions without giving these additional beneficiaries a substantial and continuing interest in the trust.

In a different instance, the Tax Court rejected the IRS’s narrow view with respect to denying the annual exclusion for withdrawal powers granted to multiple beneficiaries. In the Cristofani case, the grantor set up a trust primarily for the benefit of her two children and secondarily for her five grandchildren, who received contingent remainder interests. She gave $70,000 of property to the trust in each of the two years before her death. Each of the children and the grandchildren had the right to withdraw $10,000 within 15 days after the grantor made a gift to the trust, but none of them did so.

The grantor paid no gift tax on the transfers, claiming the annual exclusion for seven recipients, which was $13,000 at the relevant time (the children and grandchildren). The Tax Court upheld the grantor’s claim. even though no withdrawals were made, the court found that no agreement or understanding existed between the decedent, the trustees and the beneficiaries that the grandchildren would not exercise their withdrawal rights. The IRS acquiesced in result only in the Tax Court’s decision in Cristofani. Despite the Tax Court’s decision in this case, and the IRS’s acquiescence, it is clearly inadvisable to proliferate the number of beneficiaries holding a Crummey power to the point where it becomes clear that gift tax avoidance is the primary motivation.

Care should be exercised to avoid even the appearance of collusion or any prearranged agreement or understanding between the grantor and those with withdrawal powers as to the non-exercise of their powers. Indeed, they should be given to understand that, if circumstances arise which make it appropriate for them to exercise withdrawal power, they should feel free to do so.

The five-and-five power

As mentioned above, the five-and-five power refers to the maximum amount a beneficiary can withdraw or allow to lapse and still retain the benefits of the annual gift tax exclusion. The Code sets up a safe harbor provision which states that if the power is to withdraw the greater of $5,000 or 5% of the trust corpus, the lapse of such power is not considered a gift by the beneficiary.

The $5,000 limitation care raise concern since the annual exclusion is now $18,000 (in 2024, as indexed for inflation). If the beneficiary processing the withdrawal power has no other beneficial interest in the trust, the lapse in excess of the five-and-five power may be treated as if the beneficiary donated his or her own assets to the other beneficiaries. This would result in a taxable gift which will not qualify for the annual exclusion. Such an outcome, sometimes referred to as the gift-over problem, is generally not what the donor intended when the trust was created.

The five-and-five power raises a conflict between the advantage of the annual gift tax exclusion and the $5,000 or 5% limitation. The conflict lies between the grantor’s interest in maximizing the amounts that can be contributed to the trust without incurring gift tax liability and the interests of those holding Crummey powers, who are confronted with a potential gift tax problem on non-withdrawals or lapses, if their power exceeds the five-and-five limitation.

The gift-over problem

The release or lapse of a power of withdrawal in excess of the five-and-five limitation gives rise to a gift by the power holder to other beneficiaries of the trust. If the donor chooses to limit contributions to the trust so as to stay within five-and-five limitation, he or she may be forced to contribute less than the full amount covered by the annual gift tax exclusion.

The possible gift tax consequences on the lapse of a power of withdrawal are of immediate concern to the holder of the power. The grantor will not be concerned with gift tax consequences on contributions to the trust if the contributions are protected by the annual exclusion for gifts of present interests in amounts of $16,000 or less per beneficiary.

If the holder of the power is the sole income beneficiary and remainder person, the lapse of the power would not be a taxable event. This result follows from the general notion that one cannot make a taxable gift to oneself. The only sure way to avoid the gift-over problem is to stay within the five-and-give limitation.

Hanging powers

The conflict between the annual gift tax exclusion and the five-and-five limitation used to be solved by giving the beneficiary a hanging power of withdrawal. Hanging powers have been questioned by the IRS. Assuming the use of a hanging power, the withdrawal powers with respect to the property in excess of the five-and-five limitations will hang or continue in effect from year to year. Under this approach, the withdrawal power, up to the five-and-five limitation, lapses in any given year. This is done by adding a clause to the Crummey provision which converts the withdrawal power (at its expiration) to a special power of appointment. The beneficiary has a cumulative special power of appointment; and the amounts subject to the power are the total amounts that exceed the five-and-five limitations and could have been withdrawn annually but, in fact, were not.

There has been IRS activity with regard to the use of hanging powers. Technical Advice Memorandum 8901004 challenges hanging powers as a means of protecting from gift tax the portion of gifts in trust that exceed the 5 and 5 power. The IRS advised that when a condition or a right of withdrawal provides that the right will not lapse until such lapse will not result in gift tax, the condition is not valid. The IRS stated that the trust provision was a condition subsequent and that any attempt to make the lapse of the power subject to a condition subsequent makes the annual gift tax exclusion unavailable.

Until the resolution of a possible controversy with IRS on the issue of hanging powers, planners may wish to design hanging powers to avoid imposing what the IRS considers a condition subsequent. This may be accomplished by drafting a power that does not refer to a lapse or release. Instead the trust can contain a provision that causes powers to lapse only in the amount permitted under IRC Section 2514(e) which is the greater of $5,000 or 5% of the trust principal.

Some planners may wish to ignore Letter Ruling 8901004 and continue to use hanging powers. If a client’s advisor thought it was necessary to use a Crummey provision in excess of the five-and-five power, then the only option is to use a hanging power. It may be especially appropriate to do so where a large policy of life insurance, demanding a large annual premium payment, is owned by the trust, and the client will need maximum use of annual exclusion gifts. So long as the planner makes the client aware of the risk of IRS challenge (which may not arise for many years after the creation of the trust), and a record is made of the client’s informed decision, the planner and the client can take a reasonable risk. In this type of situation, it might be best to use a simple hanging power where the beneficiary retains a general power of appointment over the poverty that exceeds the five-and-five limitations.

The attack on hanging powers may not be of practical significance where the amount of premium contributed annually does not exceed $5,000 per Crummey beneficiary. For example, a trust obligated to pay a $20,000 annual premium and that has four beneficiaries should not be affected.

The hanging power is advantageous when a modified-premium policy design is used to fund the trust. During the premium paying years, the beneficiaries will allow prior withdrawal amounts in excess of the 5 or 5 limitation to hang. When contributions to the trust for premiums cease, the beneficiaries’ hanging powers will begin to lapse in an amount equal to the greater of $5,000 or 5% of the trust assets.

Hanging powers are not without drawbacks. The primary disadvantage is the cumulative nature of the power and the possibility that the holder might exercise in the future. This differs from the more typical Crummey power which is non-cumulative. The beneficiary’s right to withdraw the money in a future year before all powers have lapsed may be of concern to grantors with minor children whose powers do not completely lapse before they reach the age of majority. At majority, the children are able to exercise the withdrawal rights for the first time by themselves.

A second disadvantage relates to the death of the powerholder prior to the lapse of the entire hanging amount. At the time, the amount still subject to the power at the holder’s death will be included in the holder’s gross estate.

Choice of trustee

The choice of trustee is an important consideration in setting up a trust. The trustee, as a fiduciary, has the duty to act for the benefit of others with a high degree of loyalty, honesty and accountability. A common concern is deciding between a corporate (and therefore independent) trustee and an individual (often related) trustee. Tax concerns also play a major role in selecting an appropriate trustee for an irrevocable life insurance trust. Estate tax considerations dictate that the insured(s) not serve as trustee of an irrevocable life insurance trust. Also not recommended as trustee would be the insured’s spouse.

If an individual trustee is selected, the trust document must provide contingency plans in the event that the original trustee dies or becomes incapacitated. Also, if the individual trustee is a family member, that person is often placed in an uncomfortable position as the possibility for a conflict of interest exists. Other issues to consider in selecting a trustee is that an individual trustee may have difficulty in monitoring changing tax laws and keeping current in order to manage the trust. Also, corporate trustees are under close scrutiny for their actions, whereas individuals may be more vulnerable to breaches of trust.

The selection of trustee will depend on the circumstances of each case. Family situations typically dictate the need of a certain type of trustee. The attorney drafting the trust document would be in a position to advise on the appropriate selection of a trustee.

The notice requirement

The trustee has the responsibility to notify the beneficiaries anytime a gift has been made to the trust. For this reason, we recommend annual gifts to the trust to pay premiums. Annual gifts of premium will keep the frequency of the notice requirements at a reasonable level. This notice allows the beneficiaries the opportunity to exercise their Crummey withdrawal rights. Notice should be in writing and should state that the beneficiaries shall have a specific time in which to exercise the right. Typically, the beneficiaries should be given 30 days to exercise their rights.

In order for the grantor to make use of the annual gift tax exclusion the beneficiaries must have a reasonable opportunity to exercise the power before it lapses. The court cases and rulings have shown as the Crummey power, the notice requirement and the length of time available for the exercise of the power must all be taken together in order to determine if the grantor is entitled to favorable gift-tax treatment.

Split-dollar and irrevocable trusts

If your clients are owners of small C corporations, you may want to recommend the use of split-dollar in conjunction with their irrevocable trusts. In this type of situation, your clients can use corporate dollars to pay life insurance premiums. Depending on the design, the trust would pay only the economic benefit or imputed interest cost while the split-dollar plan is in force. Special consideration must be given to clients who are majority shareholders of their corporations. In order to avoid adverse estate tax consequences, they need to limit the corporation’s rights to the policy by using restrictive split-dollar assignments and agreements.

Potential problem areas

There are several areas that may cause some problems with regard to irrevocable life insurance trust planning. For instance, what do you need to look out for when you suggest an existing policy currently owned by the insured’s spouse be transferred to the trust? What about recommending that a policy owned by a trust be exchanged for another policy and what if the insured then dies within three years of the policy exchange?

What do you need to look out for when you suggest an existing policy currently owned by the insured’s spouse be transferred to the trust?

Transfer of life insurance to the non-insured spouse was common before the enactment of the unlimited marital deduction. Some policies are still held in this way. what happens if the owner-spouse wishes to transfer it to a life insurance trust in which he or she will be a beneficiary? Will such a trust escape federal estate tax on his or her death? The answer here is no. Although the policy proceeds will escape estate taxation on the death of the insured spouse, they will be included in the estate of the survivor (the trust’s grantor) since the spouse will have retained an interest in the gifted property.

A number of approaches may be considered to remove the policy proceeds from the spouse’s estate. The safest way out for a spouse who is the owner of life insurance policies is to create a life insurance trust solely for the benefit of children and grandchildren over which he or she will have no interest whatsoever. If, however, the spouse wants or needs the income from the proceeds after the death of the insured, then the owner-spouse could give the policy to the insured spouse who, after passage of time and without pre-arrangement, might be able to create a life insurance trust naming the spouse as the life income beneficiary. Though there are no rules determining what a proper period of time is, one year may suffice. This approach might be better than doing nothing (which may result in inclusion of all or part of the proceeds in the estate of the surviving spouse).

What about recommending that a policy owned by a trust be exchanged for another policy and what if the insured then dies within three years of the policy exchange?

If the trustee exchanges a life insurance policy held inside an irrevocable life insurance trust for a new policy within three years of the insured’s death, will the new policy be included in the insured’s estate? No, according to Private Letter Ruling 8819001, where the trustees of the trust applied for the policy and the insured’s only involvement was to sign the application and attest to its correctness.

Alternative to irrevocable trusts

If your clients are opposed to setting up irrevocable life insurance trusts, they may want to name their children as owners and beneficiaries of the life insurance policies on their lives. Through the use of the annual gift tax exclusion, the parents can gift the money to the children so that the children will be able to pay premiums. By having the children own the policies, the death proceeds will be kept out of both of their parents’ estates – a desired goal. Even though the proceeds are excluded from the parents’ estates, there are disadvantages to making the children the outright owners of the life insurance policies. These disadvantages include:

The children may be immature and misuse their rights of ownership. For example, they may cash in the policies prior to the insured’s death and use the cash for their own purposes.
After the death of the insured, the children may not be willing to use the proceeds for estate liquidity purposes. This is particularly true when the children are not the primary beneficiaries of the estate.
If the children are the owners of the policies, the proceeds will become part of their estate for estate tax purposes to the extend they are not spent during lifetime.
If the children are not the owners, they cannot permit any portion of the proceeds to be available for the surviving spouse’s lifetime use without possible gift tax consequences.

Conclusion

The irrevocable life insurance trust can bring about large estate tax savings for those clients with substantial estates. In these cases, the need for liquidity is great and typically these clients already own sufficient personal insurance for basic needs and/or retirement income. Therefore, the use of an irrevocable life insurance trust can be the ideal solution to ensure that estate taxes and expenses do not overrun the client’s substantial estate.

This material provides general information designed to be educational in nature and is not intended as specific tax or legal advice to any particular individual nor the law of any particular state. Tax lawas and applicable legal requirements are subject to change. Clients should consult with a qualified tax or legal professional regarding their specific situation.

FOR FINANCIAL REPRESENTATIVE USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC.

762265FMA-Web 05-25

Life insurance trusts

Protecting your client’s legacy is an important estate planning goal. Estate taxes and creditors can threaten to deplete your client’s wealth. If these are important considerations for your client, your client may be interested in a wealth preservation and protection strategy known as an Irrevocable Life Insurance Trust (ILIT).

What is it?

An ILIT is an irrevocable trust that goes beyond basic estate planning. While an ILIT can hold many different assets, it is primarily designed to hold life insurance. When structured properly, policy insurance proceeds pass free of both estate and income taxes and are shielded from many types of creditors.

Estate tax management

Taxable estates are subject to a top federal estate tax rate of 40% under current law. Moreover, roughly one-third of states impose a separate estate tax which can impact even modest estates. A properly funded ILIT can help mitigate (or eliminate) the tax burden.

Creditor protection

ILITs are an excellent planning vehicle for creditor protection in many states. If your client works in a high-risk profession or are otherwise concerned about creditors, an ILIT may be appropriate to help your client manage risk. ILITs can also offer creditor protection for your client’s beneficiaries who may have concerns of their own.

How does it work?

Your client and their estate planning attorney establish an ILIT that fits their needs. As the trust’s creator, your client is known as the “grantor.” Your client appoints a trustee to manage trust assets and make distributions to beneficiaries. The ILIT will own and be the beneficiary of a life insurance policy (typically on your client’s life). Each year, your client gives funds to the ILIT to pay policy premiums.

At the death of the insured, the trustee receives tax-free life insurance proceeds and manages or distributes the funds to beneficiaries according to the terms of the trust document.

The benefits

Life insurance policy proceeds pass free of both estate and income taxes in a properly structured ILIT, making this a powerful wealth transfer technique for the benefit of your client’s heirs.
ILITs are a highly effective way to provide liquidity to your client’s estate. The trustee can typically make loans to or buy assets from your client’s estate, providing a mechanism for much-needed liquidity for estate settlement needs.
ILITs can be structured with a lifetime payout for your client’s beneficiaries. This can be a powerful alternative to the Stretch IRA, a common planning technique eliminated by the SECURE Act for many non-spouse beneficiaries.
The trust can be designed to delay distributions to beneficiaries who need assistance with asset management or who are concerned about creditor or divorce.
The funds your client gifts to the trust each year to pay policy premiums can be structured to take advantage of annual gift tax exclusion amounts, making this a powerful leveraging technique.

Additional considerations

In most cases, your client should not be the trustee of their own ILIT.
ILITs are irrevocable and can be very difficult to change. However, the ILIT can be drafted with language to provide some flexibility. For example, the trust might give your client the power to substitute assets of equivalent value at a later date.
As a general rule, your client will not have access to policy cash values for their own benefit. Your client can add their spouse as a trust beneficiary using a type of ILIT known as a Spousal Lifetime Access Trust (SLAT), unlocking access for the benefit of their spouse for limited purposes (typically health, education, maintenance and support).
If your client gives an existing life insurance policy to their ILIT, the estate tax benefits are generally only realized if the insured outlives three years following the gift.
Creditor protection varies by state. If creditor protection is a concern for your client, they should consult their attorney to discuss their particular situation. As a general rule, it is best to create an ILIT well in advance of any potential creditor claims or lawsuits.
Your client should work closely with their attorney and tax professional to make sure they and their trustee have the appropriate documents and filings to maximize tax advantages of the ILIT.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2312-FP-Web 03-25

Special needs planning

As a parent or caretaker of an individual who has special needs, your client wants to make sure their loved one is taken care of after they are gone. Establishing a special needs trust on behalf of the individual and funding it with a life insurance policy may be the answer.

What is a special needs trust?

A special needs trust is designed to help your client leave behind assets with the assurance they will be used to support an individual with special needs. The trust is created to take care of any supplementary needs the individual may have that are not covered by government benefits. Once the basics of food, shelter, medical care, and education are met by the government, the trust can provide additional funds to enhance the quality of life of the person with special needs. Using a special needs trust allows your client to provide for a loved one without jeopardizing his or her eligibility for need-based benefits.

How does it work?

A special needs trust is typically funded with a permanent life insurance policy on the life of the caretaker(s) of the person with special needs. The cash value in the life insurance policy accumulates on a tax-deferred basis and can be accessed by the trustee on a tax-favored basis, via policy loans. At the insured’s death, the death benefit is paid to the trust and the trust coordinates the funds with government benefits to provide financial resources for the care and support of the person with special needs. The death benefit of the life insurance policy passes to the trust on an income-tax free basis.

The benefits

The special needs trust is designated to coordinate with other programs, thereby helping the individual to remain eligible for state and federal government benefits.
Through a special needs trust, the caregiver can feel more confident regarding the future financial security of his or her loved one with special needs.
Cash value from the life insurance grows tax deferred and can be accessible during the life of the caregiver via loans.
Proper planning can provide for the individual’s continued support, quality of life, and dignity.

Additional considerations

The strategy will require the assistance of an attorney who specializes in special needs planning, along with a financial professional.
The individual with special needs generally should not be a designated beneficiary of any retirement accounts, life insurance, annuity contracts or brokerage accounts. These financial assets could jeopardize eligibility for government benefits.
When a special needs trust is used, the trust beneficiary cannot have direct access to assets – trust distributions should be at the trustee’s sole discretion.
Life insurance may be needed on the lives of the primary caregiver AND the primary breadwinner, if not the same person.

THIS MATERIAL IS FOR USE WITH THE GENERAL PUBLIC AND IS NOT INTENDED TO PROVIDE INVESTMENT, INSURANCE OR TAX ADVICE FOR ANY INDIVIDUAL.

Form 2293-FP-Web Rev. 03-25