A Time For Wait-and-See Estate Planning Techniques

Estate tax reform continues to sustain momentum–insurance producers, estate planners and clients continue to ask how to set up estate plans in an uncertain tax environment.

After all, irrevocable gifting and irrevocable life insurance trusts are not as popular in light of the constantly changing estate tax landscape. Many commentators have pointed out that financial advisors should help clients adopt flexible estate plans that will help them cope with changes. In many cases, flexible estate plans should be adopted.

Life insurance, especially flexible premium products such as universal life and survivorship universal life, can and should play a key role in many of these plans. In these wait-and-see estate planning techniques, the value of owning life insurance can be the focus, while taking into account estate tax planning considerations.

Single Life Policies. One example of a wait-and-see estate planning technique that may incorporate the use of a single life policy is the disclaimer trust technique.

A disclaimer is an irrevocable written refusal by a beneficiary to accept property from a decedent. It must be filed prior to the beneficiary receiving the property and within nine months of the date of the decedents death. It is also important to note that the person disclaiming the property must not be a minor. If the disclaimer is valid, the disclaimed property passes as though the person disclaiming the property predeceased the decedent so that no additional transfer tax is imposed.

For example, Harry Husband could own a universal life insurance contract on his life and name his wife, Wanda, as primary beneficiary. Variable universal life may also be a choice if Harry and Wanda want more potential growth of the cash value, while taking more risk with respect to the equity subaccounts. The disclaimer trust strategy works regardless of the policy type. Harry could name his trust as the contingent beneficiary.

Upon Harrys death, Wanda may choose to keep the insurance proceeds, especially if estate taxes are repealed. However, if estate taxes are not repealed, Wanda may disclaim the life insurance proceeds. Harrys trust would then be the beneficiary of the insurance proceeds.

Assuming Harrys trust contains exemption equivalent trust provisions in addition to marital trust provisions, part or all of the insurance proceeds may be allocated to the exemption equivalent trust (credit shelter trust), to help maximize transfer tax savings.

The amount allocated to the exemption equivalent trust should not be included in Wandas taxable estate at her death and eventually would be distributed to trust beneficiaries estate tax-free. The disclaimer trust arrangement provides flexibility so that Wanda, as the surviving spouse, decides how much she needs after Harrys death. Wanda should, of course, seek legal and financial counsel when making such decisions.

Wanda is not obligated to disclaim the insurance proceeds. So, if Harry and Wandas estate plan requires them to guarantee benefits to anyone other than Harry and Wanda, they should employ other estate planning techniques to achieve such objectives. For example, Harry and/or Wanda may have children from a previous marriage for whom they want to provide. A disclaimer trust would not be appropriate in such situations.

In the event Wanda dies first, the disclaimer technique provides Harry with control of the universal life insurance contract. Harry may keep the policy, gift it or sell it. If estate taxes are repealed, Harry may choose to keep control of the policy and use the flexibility of the universal life product to his advantage. He may decide to pay premiums or skip premiums. If a reduction in the death benefit is not a concern, he may decide to access the cash value through withdrawals and, perhaps, loans. Of course, Harry may also name a new beneficiary.

If estate taxes are not repealed and are expected to be applicable to Harry, he may decide to gift the policy to his children or to his trust. Of course, gift tax considerations, and the rule that generally applies the estate tax to life insurance that is transferred within three years of death, should be taken into account.

In addition, Harry could establish an irrevocable life insurance trust that qualifies as a grantor trust and sell the policy to this trust. Arguably, if Harry sells the life insurance contract to a grantor trust, there should be no income tax consequences and there should be no transfer for value because the IRS generally considers the grantor and a grantor trust as the same person for income tax purposes.

Furthermore, if the policy is sold to Harrys trust, the three-year rule should not apply and the contract should be excluded immediately from Harrys estate–assuming that the trust is properly structured.

Of course, Wanda could also own a policy on her life and establish a disclaimer trust of her own to mirror Harrys arrangement. She would then have the same flexibility and options outlined for Harry.

Single-owned Survivorship Arrangements. Another wait-and-see estate planning technique is the single-owned survivorship (SOS) technique. In this technique, a survivorship universal life or survivorship variable universal contract is owned by one of the individual insureds. The client controls the contract and has the ability to control the cash values during life.

For example, in a typical SOS arrangement, Harry and Wanda want a flexible estate plan incorporating their survivorship contract. Assuming Harry has the shorter life expectancy, he would own the survivorship contract in his name. Harry may create a revocable living grantor trust and name the trust as contingent owner.

By owning the contract outright, there is no requirement to gift premiums to a trust. Harry retains control over the contract. Wanda is an insured but not an owner of the contract. At Harrys death, Harrys trust becomes irrevocable and the surviving spouse would be a beneficiary of the trust.

Remember that Harrys trust is the contingent owner. Upon death, Harrys trust would be the owner of the survivorship policy. No death benefit is paid at the first death, so there is no concern about estate taxes on the death benefit. However, the cash value would be included in the owners estate.

Assuming that Harrys trust contains exemption trust and marital trust provisions, the exemption equivalent trust (credit shelter trust) could receive the survivorship contract, plus any additional assets necessary to take advantage of the federal estate tax credit.

For example, if Harry dies in 2003, the exemption equivalent is $1 million, assuming no lifetime use of the exemption equivalent. Therefore, Harrys exemption equivalent trust could receive up to $1 million of cash surrender value and other assets without creating a federal estate tax liability. Depending upon how the trust is drafted, Wanda may have some income rights under the terms of the exemption equivalent trust.

What if Wanda dies first? In that situation, Harry would be left owning the life insurance contract. As was the case in the disclaimer trust technique, Harry may keep, gift or sell the contract.

What if there is a simultaneous death? Both spouses also should establish wills with simultaneous death provisions, stating that the owner-spouse is assumed to die first.

The single-owned survivorship concept and the disclaimer trust concepts are not stand-alone estate plans. Rather, both concepts focus on flexibility and demonstrate that life insurance is an important and valuable part of a clients portfolio of financial products.

Brett W. Berg, J.D., LL.M., CLU, ChFC, is director of advanced sales for Nationwide Financial, Columbus, Ohio. His e-mail is bergb@nationwide.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 25, 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.