Talking About Life Insurance Trusts

Introduction. People are often surprised to find out that their life insurance proceeds will be part of their taxable estate at death -- even if the proceeds are payable to others, such as a spouse, children or other loved ones. 

What about the Estate Tax Exemption?  Every person has an exemption from Federal estate tax, so it’s only if the total estate (including the life insurance proceeds) exceeds the exemption that Federal estate tax is a concern.  Currently that exemption is the largest it has ever been, at $5,340,000 (or over $10 million for a married couple combined).  But that doesn’t necessarily solve all tax problems.  First of all, there is a risk that Congress will shrink the exemption in the future (it was $1 million only a few years ago).  Second, affluent professionals with young families may carry large amounts of insurance – and the insurance together with their other assets may put them over the taxable threshold.  In addition, there are cases where substantial insurance is purchased either to provide directly for children or other relatives at death or for other reasons (for example, to furnish liquidity to pay estate tax at death), and the estate planning benefit depends on the insurance not being part of the taxable estate.  Finally, some states (including NY) still impose an estate tax at $1 million, which must be addressed in the planning process as well.

What about the Marital Deduction? A person can leave property to his or her spouse free of estate tax under the so-called “marital deduction” (subject to special rules if the spouse is not a U.S. citizen).  However, the marital deduction merely postpones the estate tax until the death of the surviving spouse, it does not eliminate the tax.   Moreover, obviously, not all persons who purchase life insurance are married.

Is there a way to get life insurance proceeds out of the taxable estate? Yes, the solution is to transfer the insurance policy during lifetime (and at least 3 years prior to death) to an irrevocable life insurance trust, also known as an “ILIT.”

What is an ILIT?  As the name implies an ILIT is an irrevocable trust designed to hold a life insurance policy.  The person who creates the trust is called the “grantor,” there is a trustee  who is in charge of managing the trust property, and the trust is for the benefit of family members (spouse, children, etc.) and/or other loved ones, who are called the beneficiaries.  Irrevocable means the grantor cannot change the trust after it is created –this is necessary to keep the insurance proceeds out of the taxable estate. 

Who can be the Trustee of an ILIT? Generally, anyone other than the grantor can be the trustee of the ILIT.  For example, if the ILIT holds an insurance policy on the life of a husband, generally his wife can be the Trustee.  It is usually good to also have an independent trustee (who could be close friend or even a family member, such as a parent, who is not a beneficiary of the trust) or at least a mechanism to appoint one.  The trustee should agree not to receive any compensation for acing as trustee of the ILIT, at least during the grantor’s lifetime, because the ILIT will probably not be worth much until after the grantor dies when the insurance proceeds are received.

What happens to the property in the ILIT?  Usually the ILIT says that as long as the grantor is alive, the trust property will be held in a trust for all of the beneficiaries.  For example, a typical ILIT for a married person might say that during the grantor’s lifetime, the trust is for the grantor’s spouse and all descendants of the grantor.  After the grantor dies, many different things could happen to the property – it could continue to be held in trust for all the beneficiaries, it could be divided into separate trusts for different beneficiaries, or it could be paid out to the beneficiaries.   That is something the grantor would decide in consultation with his or her estate planning attorney at the time the ILIT is created. Remember that the ILIT usually will not be worth much until the insurance proceeds are received after the grantor’s death.

How does the grantor transfer the insurance to the ILIT? The grantor transfers the insurance to the ILIT by filling out a change of ownership form and delivering it to the insurance company.  As the new owner the trustee of the ILIT must then fill out the appropriate insurance company form naming the ILIT as the beneficiary of the life insurance.  Sometimes both those steps can be taken on a single form.

What if you are thinking about getting insurance but haven’t yet applied?   In that case it’s better to set up the ILIT first, and then let the ILIT apply for, purchase and own the insurance from the start.  That way, you are not subject to the 3 year waiting period. 

Who pays the premiums on the insurance after the insurance is transferred to the ILIT? Usually the grantor continues to pay the premiums after the transfer to the ILIT.  Those payments are considered gifts to the ILIT, but they can be set up to fall under the $14,000 annual exclusion in most cases.  There are some special provisions (called “crummy withdrawal powers”) that have to be in the ILIT, and there is some minor annual paperwork that is required in order to qualify for the annual exclusion.  This is the most common plan for premium payments and works well in most cases.  If it is not suitable, an estate planning attorney can recommend an alternative structure.

 Disclaimer – Postings Not Legal Advice

This blog is not legal advice and no attorney-client relationship is formed.  The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice.  The law changes frequently and varies from jurisdiction to jurisdiction.  Being general in nature the information and materials provided may not apply to any specific circumstances.  Nothing on this blog is intended to substitute for the advice of an attorney.  If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.

Top 5 Tips for Effective Trust Drafting

Top 5 Tips for Effective Trust Drafting www.zeekbeek.com

1. Flexibility. The first rule of real estate?  Location, location, location.  The first rule of trust drafting? Flexibility, flexibility, flexibility.  Of course you can't always afford the perfect house in the perfect location, but you make the best choice you can under the circumstances - and it's the same with trust drafting.  Unfettered discretion can put a lot of pressure on the trustee (and on the trustee succession provisions), and sometimes it's just not warranted or even appropriate.  But one should strive to make every trust as flexible as possible consistent with the settlor's wishes and the practical realities of budget and family situation.  Creditor protection, tax planning, and positioning for unanticipated family circumstances are all enhanced by flexibility.  Just as an example, we have encountered a marital trust that permitted principal distributions only for a standard of support and health, which prevented a complete invasion and termination of the trust, even though that was desired by the family and would have facilitated overall estate planning. 

2.  Trustees.  A trust is only as good as the trustees.  Does this mean the trustee must be as good of an investor as Warren Buffet? No.  But if the trustee is not a savvy investor, the trustee has to be prudent enough to follow good investment advice -- for example, Warren Buffet's own advice to the trustees for his wife, to invest in an index fund! Beneficiaries who are adult and reasonable can be co-trustees and participate in investment decisions as well.  This can help them learn about money management.

 It's usually a good idea to have at least one non-beneficiary trustee (or a mechanism to appoint one) as it may be important for such a trustee to exercise certain powers, for example, to fully invade and terminate the trust.  Keep in mind that a trust can also be drafted so that different trustees are responsible for different functions (e.g., there can be a trustee responsible for making investments, and a trustee responsible for deciding about distributions).

Trustee compensation should be specified, keeping in mind that family members are often wiling to act as trustee without compensation.  Authority to resign, to name a successor, and to name co-trustees are also important to include in trust instruments.  Tax matters aside, a mechanism to remove and replace trustees is also advisable if the trust is going to last for awhile, such as for the life of a named person or persons. 

3.  Grantor Trust – or Not? In the case of a lifetime trust, one must always ask -- is this trust going to be a grantor trust for tax purposes, or is it going to be a separate taxpayer?  Of course a revocable (living) trust is always a grantor trust.  But in other cases the way the trust is drafted may control the income tax status.  There are wealth transfer benefits to grantor trust status, not to mention flexibility for subsequent transactions.  If grantor trust status is deliberately structured, however, it's important also to draft the trust with an "off switch" to terminate that status should it become preferable to do so in the future.

4.  Be Creative! The renowned 19th century British scholar F.W. Maitland thought trusts were the greatest achievement of English jurisprudence.  He may have exaggerated, but they are pretty great, and offer a chance for the estate planning attorney to be creative in tailoring a structure to suit each individual client's needs.  Powers of appointment, unitrust interests, ascertainable standards, and interests for life are only some of the many tools available in the trust drafting toolbox. 

5. Consider the Big Picture. Each trust, and indeed each estate planning document, is only one piece of the overall puzzle.  Maybe life insurance should be in a trust for kids from a prior marriage, while retirement benefits should go outright to the surviving spouse, and the Will should divide property between the wife and kids.  If a trust is used under a Will it may well have much different terms then one created during lifetime, even if for the same beneficiaries.  For example, the client may want to have some property in a discretionary trust as a protected nest egg, but have other property in a trust with an annual payout or an ascertainable standard demand power.  Thus, it's important to step back and consider the estate plan as a whole to see how the trust will fit in and contribute to achieving the client's goals. 

Disclaimer – Postings Not Legal Advice

This blog is not legal advice and no attorney-client relationship is formed.  The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice.  The law changes frequently and varies from jurisdiction to jurisdiction.  Being general in nature the information and materials provided may not apply to any specific circumstances.  Nothing on this blog is intended to substitute for the advice of an attorney.  If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.   

How to dispose of Tangible Personal Property in your Will

How to dispose of Tangible Personal Property in your Will www.zeekbeek.com

Introduction.  Your clothing, jewelry, art work, photo albums, china, car, boat, furniture, and other physical possessions – these items are called your tangible personal property.  Whether or not these are the most economically valuable part of your estate, when it comes to emotional value they are priceless.  So how do you dispose of your tangible personal property under your Will?

In General.  Sometimes you want to leave everything you own to one person, or to a group of people.  For example, if you are leaving everything you own to your spouse, or everything to your children, or everything to your parents, then that includes your tangible personal property, so you probably don’t need a separate provision in your Will about your tangible personal property.  

Making a Specific Bequest of Tangible Personal Property.  But what if you want to single out certain items and leave them to certain people?  In that case, you do use a separate provision in your Will to make those bequests.  Let’s consider the following example, from the Will of a “Mr. Sherman Holmes”:  

If my daughter Joanne Holmes survives me, I give and bequeath to her my gold class ring, if owned by me at the time of my death.  If my brother Myron Holmes survives me, I give and bequeath to him all books written in the Latin language owned by me at the time of my death.  

Let’s analyze this provision:   

1. We have picked out certain items and given them to specific people, Joanne and Myron.
2. But only if that property is actually still owned by the Sherman at death.Why? Because Sherman might give away or sell that property between the time that he makes the Will and the time that he dies, and we don’t want that to lead to any type of confusion or even dispute between the person, say Myron, who was set to inherit the property under the Will, and the person Sherman gave or sold it to during Sherman’s lifetime.A Will is not effective until death, and a person retains every right to give away or sell their property during life regardless of what the Will says.
3. Also Joanne and Myron only get the property if they survive Sherman.Why? Because probably that’s what Sherman wanted.In other words, if Joanne has died, Sherman probably doesn’t want Joanne’s husband, or whoever else inherited Joanne’s estate, to inherit the ring. By way of comparison, consider this provision from the Will ofGrateful Dead musician Jerry Garcia:

GUITARS I give all my guitars made by DOUGLAS ERWIN, to DOUGLAS ERWIN, or to his estate if he predeceases me.

Here you can see Mr. Garcia did want Mr. Erwin’s heirs to receive the guitars if Mr. Erwin            had died before Mr. Garcia, and so the bequest of the guitars does not depend on Mr. Erwin       surviving,  unlike in our example with Joanne and Myron.

You may be wondering, what happens to the rest of the tangible personal property that is not given to Joanne or Myron? In this example it falls into the so-called “residue” or rest of the estate, and is disposed of along with all of the other estate property to spouse, children, siblings and/or whoever else is inheriting the general estate under the Will. 

Potential Problems with Tangible Personal Property.  If family relationships are good it may be quite practical for two people to informally share an item – for example, Mom can leave her engagement ring to both her daughters and they can take turns wearing it.   Alternately, by talking to family members ahead of time it is often possible for everyone to agree about the sentimental items each would most like to receive.  When family relationships are strained specifying which sentimental item each child will receive may prevent dispute, and if one item is worth much more than the others, a compensating cash bequest can be made.  But sometimes parents fear alienating one child by leaving certain items to the other(s).  In such a case formal procedures may be required.  One option is to direct the Executor to sell the tangibles and divide the proceeds, but allow family members to “purchase” (basically by exchanging the cash or other assets they would have received from the estate for the desired item).  Another option is to use a rotating selection process where children, for example, take turns choosing the items they wish in a series of rounds, with a different person getting to pick first in each round (who chooses first in the first round can be decided by drawing straws).  Any unselected items are sold and the proceeds divided equally without regard to the valuation of the objects selected.    

Personal Property Memorandum.  Some states – but not New York -- allow use a of personal property memorandum, which is separate from your Will but is mentioned in your Will.  In that case basically your Will would say that if you leave a separate signed writing disposing of some or all of your tangible personal property, your Executor should follow it.  The advantage is that you can simply make a list (as short or as detailed as you wish) of your personal property and who you wish to receive it, instead of having to spell all of that out in your Will.  You must sign the list, you should date it (to avoid confusion about which was the “final” list), you should label it “personal property memorandum,” you should keep it somewhere safe but accessible (preferably with your Will), and you should not contradict anything in your Will.  For example if you leave your piano to your son in your Will, you should not leave it to your daughter in your personal property memorandum.  As noted, some states do not allow personal property memorandums so you need to check that before using one. 

Disclaimer – Blog Not Legal Advice

This blog is not legal advice and no attorney-client relationship is formed.  The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice.  The law changes frequently and varies from jurisdiction to jurisdiction.  Being general in nature the information and materials provided may not apply to any specific circumstances.  Nothing on this blog is intended to substitute for the advice of an attorney.  If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.