Using Immediate Annuities To Update An Estate Plan
One of the best and most often used estate-planning techniques is the marital deduction. You can leave as much of your estate to your spouse as you want, without limit, and owe no estate taxes. The estate tax problem doesn’t arise until the “second death,” when the surviving spouse dies.
At that point, taxes are due on the entire estate. For individuals with sizable estates, the tax problem at the second death can take a serious chunk out of what ultimately passes onto heirs. For that reason, many planners recommend that proper estate planning be done long before the first spouse dies.
There are a number of ways for individuals to avoid or reduce their estate taxes. Some gift their estates out to children and grandchildren while others use charitable remainder trusts (CRTs) to set aside assets for charities at death, while maintaining control over those assets during their lifetime.
But what if both spouses are fairly young and uncomfortable with gifting assets out of their estate? What if both want to leave their assets completely to family members, but only after the death of the second spouse?
In such cases, the answer is usually life insurance, purchased in amounts sufficient to cover any estate tax liability at the death of the second spouse. Prior to the mid-1980s, meeting this need required two life insurance policies, one on each spouse. Today, a single “second-to-die” policy insuring both husband and wife is generally used. This policy is typically owned by an irrevocable trust or the couple’s children.
But, where does that leave people who purchased single life policies prior to the advent of second-to-die contracts? Or, more keeping in line with history, what about those who purchased insurance on only one spouse?
Do they take the chance that the insured spouse will be the second to die? Or, do they take the chance that the surviving spouse will be able to “tuck the proceeds away” until taxes are due? Should they cash the old policy in, pay taxes on the gain, and use the remaining cash value to purchase a new second-to-die policy?
The answer to all three questions is no. In cases like this, the best answer may be to see whether riders can be added to the existing policy to cover a second insured. If thats neither feasible nor possible, another solution is to transfer cash values from the existing policy into an immediate annuity, via a tax-free 1035 exchange, to fund the purchase of a second-to-die policy. This concept is commonly referred to as an “annuity start.”
Consider the following recent case: