Life insurance, as an estate liquidity tool, is useful in wealth transfer planning. And although a life insurance policy is typically owned by an irrevocable life insurance trust (ILIT) so that the proceeds are not subject to transfer taxes, the gifts of potentially large life insurance premiums made to the trust may be subject to gift taxes.
Estate and gift taxes are one concern of clients. So, too, is the prospect of spending down wealth during their lifetime to fund long term care expenses. With average annual nursing home costs in 2005 at $66,000 and projected to increase to over $200,000 in 2030, the thought of long term care expenses can be paralyzing.
Nevertheless, many clients are often reluctant to allocate funds to an LTC policy they may never use. Clients often struggle with their desire to transfer wealth efficiently and the need to preserve assets for LTC costs.
One solution is to use a funded credit shelter trust. While keeping assets outside of the estate, the CST can fund death benefit protection and be used for long term care needs during lifetime.
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What is a Credit Shelter Trust?
The CST is an important part of most estate plans for married couples. With proper planning, at the death of the first spouse, a specified amount of properly titled assets, known as the applicable exemption amount, can be transferred to the trust free of estate tax.
In 2005 the exemption amount is $1,500,000. The balance of the estate assets, if transferred to the surviving spouse, is not subject to estate tax either since transfers to a spouse qualify for the estate tax unlimited marital deduction. Therefore, using the CST and the unlimited marital deduction, there may be no estate tax due until the death of the surviving spouse.
Because the assets in the CST reside outside of the taxable estate, the CST is a gift tax-free way to fund a life insurance policy on the surviving spouse. By including a long term care rider in the policy for a minimal cost, the leverage that the death benefit provides is flexible enough to transform the policy into a funding source for LTC expenses, outside the taxable estate.
How Does An LTC Rider Work?
Generally, long term care riders accelerate the death benefit during lifetime to cover qualifying LTC expenses of the insured, if needed. The amount of the acceleration is based on the rider contract and its requirements and limitations. In some cases, the amount of the death benefit available will be based on a percentage of the death benefit, usually up to a maximum amount.
The accelerated LTC benefits may be paid in a lump sum or on an installment basis, such as monthly. The payments can also be paid based on actual LTC costs incurred, up to a maximum.
Many of the rider features will be based on the type of underlying life insurance policy. Some life insurance contracts automatically provide an acceleration of the death benefit for specific qualifying long term care needs whenever they arise, or if death is expected to occur within 12 months.
For example, David Goodrich died in January 2005. His estate established a credit shelter trust upon his death and funded it with $1,500,000. The balance of his assets automatically passed to his wife, Janice, estate tax-free using the unlimited marital deduction.
Upon Janice’s death, all the assets in her estate, including those that she inherited from her husband, will be subject to estate tax and then transferred to her two children. Meanwhile, Janice will benefit from no reduction in her estate. She will also be a beneficiary of David’s CST should she require additional funds for her health, maintenance, education and support.
Janice has spoken with her financial advisor and is concerned about her estimated $2,000,000 estate tax liability due upon her death that will diminish the amount her children will receive. Janice is aware that life insurance can provide the liquidity that her children need but is reluctant to pay gift taxes and use current cash flow to fund the required life insurance. Janice is also concerned about the potential for long term care costs but has no interest in paying premiums into a policy she may never use.