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May 13, 2004 at 08:00 PM
Ideas For Managing Wealth
In B Trusts With Life Insurance
Estate planning with life insurance today is focused on managing wealth and risk as much as it is on saving estate taxes. One idea gaining popularity is the idea of using life insurance to manage wealth in exemption equivalent trusts. Financial advisors can play an important role by providing information to the trustee and legal advisors about variable life insurance products.
Under current law, a person can pass any size estate to his or her spouse without federal estate and gift taxes because of the unlimited marital deduction. In addition, each taxpayer also has a nonrefundable credit against federal estate and gift taxes. In 2004 and 2005, at death, assuming no lifetime gifts have been made, a person may pass $1.5 million free from federal estate taxes. The amount protected is now commonly referred to as the “exemption equivalent amount.”
We know that inadequate estate planning can result in wasting a clients credit. For example, a couples estate plan may exist entirely of jointly held assets or a simple will leaving all assets to the surviving spouse. When the first spouse dies, all assets are transferred to the surviving spouse via the marital deduction and, therefore, estate taxes at the first death are avoided.
However, when the surviving spouse later dies and passes the combined estate to his or her heirs, the federal estate and gift tax will be imposed on the transfer of assets. At that time, only the second spouses federal estate and gift tax credit will be applied to reduce estate taxes. The first spouses credit was wasted.
A common estate planning technique used to ensure that each spouse fully utilizes his or her credit is the credit shelter trust (now often referred to as the exemption equivalent trust or “B Trust”). In a typical planning scenario, when the first spouse dies, the exemption equivalent is placed into the B trust. The balance of the estate usually passes to the surviving spouse via the unlimited marital deduction, perhaps to a marital trust (“A Trust”) for the benefit of the surviving spouse.
Under typical B trust arrangements, the surviving spouse is entitled to all income from the trust for life. Usually, the surviving spouse will not be entitled to any of the principal of the trust. In some situations, some flexibility may be drafted into the trust, allowing the trustee to distribute principal to the surviving spouse for health, support, maintenance or education.
Upon the death of the surviving spouse, the trusts principal and the appreciation in those assets will pass to the principal beneficiaries free from federal estate tax.
The life insurance planning opportunity often discussed arises at the first death, when the first spouses B trust is funded. The primary issue for the trustee is how to manage the assets in the B trust. In general, the trustee has a fiduciary duty to balance the needs of the surviving spouse with the duty to preserve principal for the remainder beneficiaries. In many cases, the trustee may invest in a mix of stocks and bonds to generate income for the surviving spouse while seeking to preserve the inflation-adjusted value of the principal.
