Despite Estate Tax Uncertainty, Flexible Strategies Can Yield Benefits

By Daniel Munroe

Americans have debated the pros and cons of the estate tax since George Washington was president. Since 1797, the estate tax has been enacted, repealed or reformed nine times.

This month the debate rages on as Republicans take control of Congress, fortifying their majority in the House of Representatives and regaining control of the Senate. At the top of the agenda for the 108th Congress–as well as President Bush–is the “permanent” repeal of the estate tax. Current law calls for the tax to be repealed in 2010 and then to reappear in 2011.

The anticipated fire and brimstone over the estate tax is sure to distract your clients from what is truly important: planning their estates to protect their families financial security. Given its 200-year history, who can predict whether the estate tax will be around in 10, 20 or 30 years from now?

In analyzing both the financial and political realities (see sidebar), anyone who is prudent can come to only one conclusion: No one should gamble his or her familys financial security on the potential repeal of the estate tax.

Fortunately, there are many life insurance planning strategies designed to build as much flexibility into your clients estate plans as possible to address nearly any estate-tax scenario. There are currently three key strategies that you can offer clients that provide the flexibility they need to address virtually any future estate tax situation.

Spousal Access Trusts. An access trust allows a married couple to keep the life insurance proceeds needed for estate liquidity out of their taxable estate while at the same time permitting one of the spouses to have indirect access to the cash value of the policy. One spouse is the grantor of the irrevocable trust, and the other spouse is a beneficiary of the trust. The trustee (who is not one of the spouses) is typically given unlimited discretion to make distributions to the spousal beneficiary. An access trust can be used with either a single life or survivorship life insurance policy.

Shared Ownership Of Life Insurance. The shared ownership of life insurance allows one spouse to retain tax-favored access to the policy cash value while at the same time ensuring that the net death benefit is outside the insured spouses estate. The death benefit is received income- and estate-tax free by the beneficiary. The arrangement utilizes two owners. The residual owner typically owns the net death benefit, and the equity owner typically owns the entire policy cash value.

However, the clients can decide at the time the arrangement is implemented how to share the policys premiums, cash value and death benefit. This strategy also provides effective gift tax leveraging as the residual owners share of the premium is typically only the term cost of its death benefit protection, and it is only this amount which needs to be gifted rather than the entire premium. Shared ownership can be used with a single life policy only.

While the shared ownership strategy differs from a split-dollar arrangement, recent IRS activities in this area require further discussion.

IRS Notice 2001-10 addresses taxation of “equity split-dollar” arrangements, which are not generally applicable to the subject shared-ownership arrangements.

Notice 2002-08 revoked Notice 2001-10 and announced the IRSs intention to publish proposed regulations providing comprehensive guidance concerning the federal income-tax treatment of split-dollar life insurance arrangements.

The proposed regulations may likely apply to shared ownership arrangements entered into after the date the final regulations are published and to any existing arrangements materially modified after that date.

Premium Loans to Trust. In situations where an irrevocable life insurance trust owns an insurance policy for estate liquidity purposes, it may be advantageous in some instances for the insured to loan the annual premiums to the trust rather than gifting the premiums. This strategy enables the policys death benefit to be received income-tax free. While a portion of the proceeds is repaid to the insureds estate to cover the original loan and is therefore subject to estate tax, the remainder is received estate-tax free.

The loan strategy provides substantial gift tax leveraging–only the loan interest is considered a gift, rather than the entire policy premium. Assuming that the trust is not a grantor trust for income-tax purposes, the insured would incur taxable income as a result of the interest on the loan. This strategy can be used with either single life or survivorship policies.

What is to become of the estate tax is anyones guess. Now more than ever, clients need to be shown creative life insurance planning strategies that allow their plans to change as the tax laws change. Providing your clients with creative solutions can help distinguish you from the competition as the debate over the estate tax continues, perhaps for another 200 years.


Reproduced from National Underwriter Life & Health/Financial Services Edition, January 6, 2003. Copyright 2003 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.