The Roman scholar Pliny “the Elder” once observed that, “the only certainty is that there is nothing certain.”
He must have been talking about the federal estate tax.
The estate tax has been repealed for one year only, 2010, and will be reinstated in 2011 unless the U.S. Congress and the President agree to a permanent repeal. With five congressional elections and two presidential elections between now and 2011, few people are willing to bet the ranch on even a one-year repeal–never mind a permanent rollback.
So, what are you supposed to tell your clients? How can you possibly plan for a tax and political environment that can shift as quickly as a mudslide? You and your clients can take precautions against getting buried by any fallout from Washington, D.C. by building as much flexibility into your estate plans as possible.
The biggest concern many clients have about moving ahead with their estate plans is the commitment of significant financial resources–particularly the purchase of large life insurance policies needed to create estate liquidity–to preserve their wealth for loved ones. Theyre reluctant to relinquish control over significant assets for estate liquidity, especially if they think the estate tax may eventually evaporate.
One solution that many financial professionals and their clients have found effective is the shared ownership of life insurance. The concept of shared ownership addresses the competing objectives of (i) wealth creation and preservation through estate-tax-free ownership of a life insurance policy; and (ii) access to the cash value of such policy. Based on state property and insurance law, as well as federal transfer tax law, shared ownership is increasingly being accepted as a mainstream estate and life insurance planning strategy.
For many people, the most efficient way to preserve an estate from estate taxation is to purchase cash value life insurance as part of an irrevocable life insurance trust (ILIT) and use the death benefit proceeds to pay estate taxes. This strategy has traditionally proved to be highly effective, especially when you consider that federal estate taxes can run as high as 50% this year before being “scaled back” to 45% by 2007, and returning to a high of 55% in 2011.
While the use of a trust without shared ownership protects the life insurance policys death benefit from estate taxes, it precludes clients from tapping policy cash values to supplement their retirement needs through income-tax-free loans or withdrawals.
The inflexibility of an irrevocable life insurance trust serves to reduce or eliminate a valuable source of cash for retirement or other financial needs. Consequently, using life insurance to supplement retirement income typically requires the policys death benefit to be included in the insureds gross estate and, therefore, triggers an estate tax liability on the insurance.
Sharing the ownership of the life insurance policy knocks down those barriers by establishing one life insurance policy with two owners who share the rights, costs and values of the policy. Often, the co-owners are the insureds spouse and an ILIT, the trustee and a beneficiary of which may be the insureds spouse.
In such a scenario, an ILIT typically realizes an income tax and estate-tax-free death benefit while the insureds spouse gains income-tax-free access to policy cash values through withdrawals and loans. Of course, this arrangement assumes the policy is not a modified endowment contract (MEC) and remains in force.
In establishing a shared ownership arrangement, an agreement is created between a “residual” owner and an “equity” owner at the time the life insurance is sold. The residual owner (e.g., an ILIT), receives the risk portion of the death benefit and pays the cost of that insurance coverage. To cover future costs of the risk protection provided or for other reasons, the residual owner may also own part of the policys cash value.
The equity owner (e.g., the insureds spouse or a trust for his or her benefit) retains a death benefit equal to the policys cash value not owned by the residual owner. The equity owner has access to the policys cash values and pays the costs associated with that portion of the policy. The equity owner may use the policys cash value to supplement retirement income or for other purposes.
With careful planning, shared ownership bridges the gap between what once were competing financial and tax goals. Under a shared ownership arrangement, your clients now have greater flexibility to make the most of their financial resources–both for themselves and their loved ones.
Through a shared ownership arrangement, the policys cash values continue to accumulate tax-deferred. One policy owner, the equity owner, retains access to the cash values through policy loans and withdrawals. A substantial portion of the policys death benefit may be removed from the clients estate because the ILIT (or other appropriate person or entity) is the residual owner.
A critical component of the shared ownership arrangement is the use of variable universal life insurance. The death benefit of a variable universal life insurance policy provides an efficient means of creating estate liquidity.
But, the policy also offers a high degree of flexibility coupled with several other financial and tax benefits, including: tax-deferred accumulation of policy values invested in equities; tax-free transfers between investment options to restructure or rebalance portfolios; tax-advantaged access to policy values; the ability to direct and control investments; and dollar cost averaging and asset allocation programs.
The investment options within variable universal life insurance policies include equities, which offer long-term growth potential, as well as a wide range of other professionally managed, highly diversified separate accounts. The cash values within the variable life insurance policy accumulate tax-deferred until withdrawn and can be transferred from one investment option to another without incurring a tax liability. Your clients can reposition their investment options to meet their financial needs as those needs change throughout their lives.
Surely, you have several clients who would see a shared ownership arrangement as a boon to their financial planning goals. Clients who can benefit the most commonly have life insurance needs; understand the investment potential of equities and have significant assets to invest; are in a high income-tax bracket; and have long-term investment needs.
Beyond personal supplemental retirement and estate planning needs, the concept of shared ownership has other life insurance planning applications. It can be used as part of non-qualified deferred compensation plans (or other employer/employee arrangements), supplemental retirement plans, or cross-purchase funding for buy-sell plans.
Traditionally, life insurance benefits of other ownership arrangements (including, for example, split dollar arrangements) are divided between the policys death benefit and cash value, which may not reflect the clients true wishes or objectives.
Fortunately, the flexibility of shared ownership permits each policy owner to own between zero and 100% of such policy benefits. Accordingly, the shared ownership division between owners, unlike other life insurance planning strategies, is not necessarily tied to the term portion of the contract or term rates.
As you can see, shared ownership is a powerful financial strategy that provides participants with uncommon flexibility to make the most of their financial resources and plan for the future. Pliny “the Elder” himself might have endorsed the concept as a hedge against an uncertain future.
Nearly 2,000 years ago, Pliny saw clear to advise his fellow Romans to plan on uncertainty in their lives. That advice rings true today, especially for your clients who are planning their estates in an uncertain estate tax environment.
, JD, CLU, is assistant vice president and director of advanced markets for the individual life division of Hartford Life Insurance Co., Simsbury, Conn. His e-mail is patrick.smith
Reproduced from National Underwriter Life & Health/Financial Services Edition, April 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.