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August 24, 2003 at 08:00 PM
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 Furthermore, as the table shows, estate taxes are repealed in the sole year of 2010.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.
