Use Life Insurance In B Trust Planning For High-Net-Worth Clients

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With enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001, some of your clients may now assume they dont need an estate plan.

Of course, nothing could be further from the truth–this tax law does not guarantee elimination of tax liability over the intermediate years of gradually declining estate tax rates (2002-2009). Furthermore, as the table shows, estate taxes are repealed in the sole year of 2010. Unless Congress acts, pre-EGTRRA estate tax rules will be fully reinstated in 2011.

Therefore, its necessary to review with your clients and their advisors the use of estate planning strategies.

As financial professionals, we often explain the virtues of the “A-B” trust–a fairly typical estate planning strategy designed to reduce the estate tax liability of married couples.

The “B” trust, when coordinated with the unlimited marital deduction, is used to preserve the applicable exclusion amount of the first spouse to die, a fundamental objective in estate planning for married couples.

How the A-B Trust Works. The mechanics of “A-B” trust arrangements are simple. At the death of the first spouse, the estate is divided into two parts.

The “A” portion of the estate passes outright to the surviving spouse or is placed in a marital trust, and as such is eligible for the unlimited marital estate tax deduction. These assets are exempt from current estate taxes but will be paid at the second death.

The “B” portion of the estate of the first-to-die spouse passes on to what is known as a bypass trust or credit shelter trust. Growth and legacy assets are passed to maximize amounts that are ultimately transferred to nonspousal beneficiaries, such as children and grandchildren, so as to defer taxes.

At the death of the second spouse, the property in the “B” trust does not receive a step-up in basis (there is a step-up in basis to the value at the date of the first death), so all gain is income taxable but is not subject to estate tax.

The first step is to decide what is the best way to invest the assets in the “B” trust, given the clients individual goals, objectives and health condition.

Often the assets are placed in vehicles where the clients advisors have the most experience, be it stocks, bonds, mutual funds, wrap accounts or real estate.

But before you leap at the familiar, Id like to suggest another vehicle–life insurance.

Life Insurances Financial Advantages. Now before you discount the thought of suggesting your client put up to $1 million into a life policy, consider the financial advantages.

The life insurance “B” trust funding vehicle would accumulate tax deferred. It would be income- and, if properly structured, estate tax-free at death of the surviving spouse and have some liquidity features if the need arises.

In addition, life insurance has potential to provide leverage, so the surviving spouse could spend down the remaining assets in the “A” trust without worrying about decreasing the potential inheritance to the heirs.

Life insurance has been granted favorable tax status as stated in IRC 101(a) and whether in a trust or owned personally, generally there is no income tax on the proceeds at death.

Money growing inside the policy accumulates on a tax-deferred basis so if funds are not withdrawn or the policy surrendered, there are no tax consequences.

Clearly, if the assets are legacy assets and are not needed now or in the future to provide for the surviving spouse, and there is a need for life insurance, then it may make sense to purchase the life insurance on the surviving spouse in the “B” trust.

The “B” trust often is funded with an amount equal to the estate tax applicable exclusion amount, thereby “leveraging” the transfer tax exemptions and sheltering the “B” trust assets and their appreciation from estate taxes at the second spouses death.

Leveraging the applicable exclusion amount by purchasing assets with growth potential allows for a bigger inheritance to the children or grandchildren.

Under current estate tax law, at the first death, if it occurs in 2003, you can put up to $1 million of real or personal property into a trust and never pay estate taxes on these assets. That amount increases to $1.5 million in 2004 and 2005, and so on.

Thinking Outside the Box. If you have never considered life insurance as a “B” trust funding vehicle, youll be surprised at the potential advantages.

When properly structured, “B” trust funding with life insurance offers these potential benefits:

Life insurance proceeds payable to the “B” trust are not subject to estate taxes.

Life insurance premiums are paid by “B” trust assets and therefore dont trigger gift taxes.

Life insurance cash values grow income tax-deferred in the trust.

“B” trust assets may be used by the trustee to provide lifetime benefits to the surviving spouse, with the remainder distributed or held for the benefit of trust beneficiaries (per terms of the trust document).

Life insurance death proceeds are generally received income tax-free under IRC 101(a) and whether in a trust or owned personally there is no income tax on the proceeds at death.

To summarize, these uncertain times of erratic markets, falling retirement income, corporate malfeasance and high deficits demand thinking outside the box.

Its ironic that such thinking brings us to one of the most familiar and better funding vehicles–life insurance.

Life insurance can satisfy clients looking to the “B” trust to pass growth assets to favored beneficiaries with a minimum of transfer taxes and enough flexibility to provide for the needs of a surviving spouse.

In addition, the tax-advantaged benefits of life insurance deserve attention from even the most sophisticated financial professional and his or her high-net-worth clients.

, CLU, ChFC, CFP, is vice president, national accounts for Prudential Select Brokerage, based in San Diego, Calif. He can be reached at william.izor

@prudential.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.