ESTATE PLANNING UPDATE
To: All Estate Planning Clients
Date: April, 2000
Re: Estate Planning with Life Insurance
The death benefit proceeds of life insurance on a deceased person's life are includible in his gross estate for Federal Estate Tax purposes under a special provision of the Tax Code if the deceased person was the owner of the policy at the date of death. This includes proceeds receivable by the executor of the decedent's estate. It also includes proceeds receivable by other beneficiaries but only if the deceased person possessed one or more "incidents of ownership" in the policy at his death. Life insurance that is included in a deceased personís gross estate increases the overall size of the deceased personís gross estate which may or may not subject the estate to Federal Estate Tax based on the deceased personís estate plan and other factors. Thus, it is possible to keep life insurance proceeds out of oneís gross estate for Federal Estate Tax purposes by naming a beneficiary other than the insured's estate and giving up all ownership and incidents of ownership in the policy.
Assigning Employee Group Term Life Insurance To An Irrevocable Life Insurance Trust
The planning advantages of transferring ownership of life insurance to an Irrevocable Life Insurance Trust (ILIT) can be obtained for employee group term life insurance assigned by the insured employee to an ILIT. The same concepts and planning opportunities exist for group term life insurance coverage provided by an organization to its Board of Directors. The death benefits of the policy will be included in the insuredís gross estate because he had the right to change beneficiaries (an incident of ownership), regardless of who pays the premiums.
There is no gift tax on the transfer of the policy to an ILIT since the term life insurance policy has no ascertainable value at the time of the transfer. The employer's continued premium payments are income to the employee (nontaxable for the first $50,000 of coverage) and are gifts by the employee to the assignee ILIT. The gifts by the employee by reason of the employer's premium payments qualify for the annual gift tax exclusion as present interest gifts if the proceeds of the policy collected by the trustee on the insured's death are payable in full to the trust beneficiaries. Such gifts do not qualify for the annual gift tax exclusion, however, if only the income from the proceeds is payable to the trust beneficiaries after the insured's death with payout of the proceeds deferred until some later point in time, unless the ILIT contains special provisions.
Observation: Consequently, if the proceeds are payable to the trust beneficiaries on the death of the insured, it is not necessary to include a 'Crummey' type of withdrawal provision in the trust since under the IRS view, the employer's continued payment of premiums are gifts by the employee which qualify for the annual gift tax exclusion. However, if the trust provisions defer payout of the proceeds beyond the death of the insured, a 'Crummey' type withdrawal provision will be necessary to preserve the annual $10,000 gift tax exclusion.
Three-Year Rule Issues
Two issues involving application of the three-year rule (i.e., life insurance regarding which ownership is transferred by the insured within three years of his death is includible in his gross estate for Federal Estate Tax Purposes) to the assignment of group term life insurance have generally been resolved in taxpayers' favor. First, the annual payment of a renewal premium each year which is a requirement for group term life insurance policies isn't a new transfer of the group insurance each year for purposes of the three year rule, if there is an automatic right to renew the group policy annually without evidence of insurability. Second, if the employer changes insurance carriers after the group term insurance has been transferred, the change of coverage does not require a new three-year waiting period if (1) the change of carrier does not revest ownership of the policy in the insured, and (2) the new coverage is identical in all relevant respects to the earlier coverage.
Observation:Although a new three-year period waiting period is not required by the change in insurance carriers, a reassignment of the new policy is probably necessary.
Please do not hesitate to contact us if you have any questions or would like to discuss any of the issues or planning opportunities raised in this Estate Planning Update.