Flexibility Remains The Key To Effective Estate Planning
On June 7, 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 was enacted which, through 2009, provides for reduction in maximum tax rates, increased exemptions from taxes, and repeal of the estate tax in 2010. What are the implications of this law for estate planning?
Of significant note is the new laws “sunset” provision, which causes the law to expire on Dec. 31, 2010, and effectively reinstates the wealth transfer tax system as it existed prior to its enactment. Furthermore, even if the estate tax repeal is extended, various taxes will remain payable at death.
Consider the impact of carry-over basis and capital gains tax; annuities, qualified retirement plans and other assets attracting ordinary income tax; and state death taxes. Consequently, clients will continue to seek guidance on minimizing taxation and estate erosion, and given the uncertainties of the estate planning landscape, they will seek planning solutions that foster flexibility to accommodate changes in the law and their future circumstances or objectives.
Survivorship life insurance has long been recognized as a cost-effective and tax-efficient method of funding estate liquidity, and has played a pivotal role in many popular estate planning techniques, including the Irrevocable Life Insurance Trust. However, in traditional “ILIT” planning, the policy is owned by the trust from the inception of the plan in order to exclude the insurance proceeds from the insureds estates.
The insureds are excluded as trust beneficiaries and cannot access policy cash for education funding, retirement income, or other lifetime needs. Also, the terms of an irrevocable trust cannot be modified if circumstances or objectives subsequently change.
Therefore, flexibility, access, and control are compromised.
A Survivorship Standby Trust offers a creative solution. The “SST” accommodates the dual objectives of estate liquidity and lifetime income, using a single planning concept and financial product, while minimizing income, estate, and gift taxes. In addition, the SST promotes flexibility by permitting modifications to the plan, which does not become operative and irrevocable until death.
How does an SST work? The spouse with the anticipated shorter life expectancy is the applicant and owner of a survivorship policy insuring both spouses. The SST is designated the contingent owner and beneficiary, and receives the policy upon the death of the policyowner. The policy remains personally owned until death.
Consequently, cash value can be accessed through withdrawals or loans (generally without income tax). In addition, the premium payments are not taxable gifts, so the annual exclusion and unified credit can be conserved for other planning.
If, as anticipated, the policyowners death occurs first, the policy value (reduced by the value of lifetime withdrawals or loans) is included in the policyowners estate, but estate tax can be minimized or eliminated with remaining unified credit.
Alternatively, if the non-owner spouse dies first, the policyowner can assign the policy to an ILIT or other third party. The transfer can be sheltered from gift tax with the annual exclusion or unified credit, and if the policyowner survives three years, the proceeds are excluded from his or her taxable estate.
Since the non-owner spouse has no “incidents of ownership” in the policy and is generally excluded as an SST beneficiary, neither the cash value nor death benefit is included in his or her estate, regardless of the order of deaths.