Which of the following is better for your client? Option 1 calls for saving $150,000 in estate taxes today by giving $340,000 to the client’s 2 grown children, yielding approximately $7.1 million to the children in 45 years (at a growth rate of 7%). Under option 2, the client creates a tax-free benefit pool worth $19 million in 45 years. How about getting both the tax savings of $150,000 and the $19 million benefit within the same vehicle! (This assumes an estate tax rate of 45%.)

A parent or any person can gift up to $12,000 per year to each donee. Gift-splitting with a spouse can double that to $24,000 per year per child. Many financial advisors and their estate planners use the gift tax exclusion as a normal technique in estate planning. What is less well known-but accepted as settled law–is that gifts made directly to an educational facility or for medical expenses can be made on behalf of the same child above that $12,000/$24,000 level.

A “qualified transfer” is not considered a gift for gift tax purposes, which means that payments to any person or corporation that provides medical care as defined in IRC~213(e) becomes the exception to the gift tax exclusion limit. Gifts made directly to a medical plan or medical practitioners are in addition to the standard $12,000/$24,000 gift limits.

Therefore, individuals who are already maxing out gift potential may still purchase long term care insurance for their child or grandchild and remove a substantial amount of assets from an estate. In a recent case, the numbers worked like this:

To give the same potential benefit to the client’s children, the client would have needed a conservative investment, which would have paid a consistent 9.4% after tax return for 45 years!

The key is that payments must be made directly to the medical practitioner or directly to the insurance company that sponsors the medical plan (IRC ~ 2503(e)). According to IRC~7702B, long-term care insurance qualifies as a medical plan and the benefits are received tax-free (IRC~105 (b)).

Among the major considerations for any estate-planning practitioner is that the insurance company must be stable and expected to still be in the long term care insurance business in 45 years. Having high financial ratings in not enough since an insurance company’s “book of business” can be sold like any corporate asset.

The key is the company’s commitment to the long term care industry as evidenced by those companies that have their own in-house claims and in-house underwriting departments, the experience of designing profitable products and adjudicating claims. The company should also have a high financial rating and good sales channels.

The illustration for this article is based upon a benefit in current dollars of $7,500 per month for 6 years. The hypothetical parents gift the maximum amount per child, leaving no other assets to the second generation. Both in their mid 60s, the parents do their gifting program with 10-pay premium LTC policies so the insurance contracts are paid up before they pass away (age 65 to age 75).

Once gifted, the paid-up LTC policies are owned by each child and their spouses, removing the policies from the parents’ estate. Because the premium payments each year are irrevocable, each premium payment is considered to be a completed gift of a present interest and is not subject to 3-year look back considerations. (The mere fact that a bond, note, or insurance policy is payable in the future does not make ownership of it a “future interest,” according to Treasury Reg. 25.2503-3(a)).

Transferring assets to the next generation in a tax-advantaged manner is one part of estate planning. The ability to also protect the next generation from devastating expenses in their elder years can give peace of mind to the parents and protect other gifted assets from medical financial pressures that cannot be foreseen. Estate planning is not just about saving tax dollars, but protecting the next generation and enabling family values to continue. The gift of a long term care insurance policy to the children can contribute to these goals.