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Financial Planning > Trusts and Estates > Estate Planning

Speakers Put Sizzle In Estate Planning

By Warren S. Hersch

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ST. PETERSBURG, FLA.–Why is life insurance valuable as a source of liquidity? How can a policy enhance the value of an estate, stabilize a business interest or mitigate the impact of income tax rates? What role can death proceeds play in maximizing IRA plan distributions and Roth conversions?

These questions, among others, were addressed during a workshop at LIMRA International’s Advanced Sales Forum, held here Aug. 12-14. The session, “Sizzling Uses of Life Insurance in Estate Planning,” brought together a panel of advanced sales experts from Prudential Financial, Mutual Trust Financial Group and Allianz Life Financial Services.

Terri Getman, a holder of the Chartered Financial Consultant designation and vice president of advanced marketing at Prudential Financial, Newark, N.J., kicked off the panel discussion by talking about life insurance’s role in replacing income. The vehicle can be used to replace the income of a deceased young wage earner or an individual who is asset-rich but income-poor via an income-only trust, she said.

Life insurance proceeds can also be used to retire debts, pay for services formerly provided by a deceased (such as house-cleaning, child care and cooking), fund a child’s college education or satisfy the care of individuals with special needs, said Getman.

Life insurance can also provide a source of liquidity to help pay federal and state taxes and other final costs. In a typical situation involving a large estate, a married couple establishes a family trust sheltered by the $3.5 million per individual estate tax exemption ($7 million per couple), the balance of property passing to a U.S. citizen spouse under the unlimited marital deduction. said Getman.

“This delays the federal estate tax until the death of the surviving spouse,” said Getman. “To pay the estate tax, the couple can fund a second-to-die life insurance policy residing inside an irrevocable life insurance trust or, alternatively, a stand-by survivorship trust or a ‘B’ trust.”

Life insurance proceeds can help address the marital deduction limitations of a non-citizen spouse, Getman added. For this individual to qualify for the unlimited marital deduction, property must pass into a qualified domestic trust. However, distributions of principal from the trust are subject to estate tax, except in hardship cases. And assets remaining in the QDT at the death of the non-citizen spouse do not qualify for the estate tax exemption.

Getman, noted, too, that life insurance can boost the size of an insured’s estate, thereby tempering potential family conflicts. The death proceeds may be used to provide funds for children from a prior marriage, for example, meet the requirements of a divorce decree (such as a child support), pay for a business interest or equalize the inheritances of heirs who do not work in a family business.

As to stabilizing a business, Rakesh Bedi, a holder of the Certified Financial Planner designation and director of advanced sales and sales support at Mutual Trust Financial Group, Oak Brook, Ill., observed that a policy’s death proceeds may be used to satisfy business debts, provide needed cash flow following the death of a key employee and create a bonus fund to retain key employees during a transition period of the business.

A high cash value life policy owned by a complex trust can help mitigate the impact of compressed trust income tax rates, which run as high as 35% on taxable income exceeding $11,150 annually, he added. That’s because the cash value grows tax-deferred. And, at the death of the insured, proceeds pass income tax-free to policy beneficiaries.

Bedi observed also that policy death proceeds can increase the efficiency of assets, such as an individual’s applicable estate and gift tax exclusion amounts or a generation-skipping transfer tax exemption amount.

“Using a low premium whole life policy, an individual who is 60 years of age can secure a death benefit that’s many multiples of the annual premiums,” said Bedi. “A $50,000 annual premium can, for example, provide close to $1,700,000 in death benefit. That’s pretty good leverage.”

Life insurance can fulfill multiple functions as well in retirement planning. Jim Johnson, a Chartered Financial Consultant and vice president of advanced sales development at Allianz Life Financial Services, Minneapolis, Minn., cited using life insurance to help qualified plan participants and IRA owners make the most of their ability to stretch retirement account distributions.

Under a basic stretch plan, a 401(k) participant or IRA owner delays distributions for as long as permitted by a uniform or life expectancy table. The individual names a young beneficiary, such as a child or grandchild, that will minimize distributions and, at the mandated age of 70 1/2 , distributes the minimum amount required.

Earnings on the account can continue to growth tax-deferred, creating potentially substantial wealth for future generations. And, assuming the account owner has other retirement assets to live on, the unused RMDs can fund premiums of a life insurance policy that later may be used to pay estate taxes–thereby maximizing the stretch.

To illustrate, Johnson cited a hypothetical couple, Jack and Jill, ages 70 and 64, respectively. Jack, the owner of an IRA valued at $500,000, names his wife as the beneficiary. After beginning required minimum distributions in December of 2010, Jack dies at age 72 with an account valued at $537,252 (5% growth, less the RMDs).

Jill, now age 66, treats the IRA as her own and begins taking distributions when she reaches 70 1/2 . As IRA owner, she names her grandson, John (age 13), as the account beneficiary. Jill subsequently lives to age 75, receiving distributions for 6 years. John, now age 22, takes distributions totaling nearly $5 million over his lifetime of 61.1 years, netting around $3.25 million after paying a 35% income tax on the distributions.

To maximize distributions to John, estate taxes due at Jill’s death are covered by a survivorship life insurance policy on the lives of Jack and Jill, Jack’s unneeded RMDs being used to fund the premiums, Johnson added.

Death benefit proceeds can also be used to help replace assets lost to income tax on income in respect to a decedent. These IRD assets are subject to income tax even if the estate is not subject to estate tax, said Johnson.

“The thing that surprises most people is what constitutes IRD assets,” he said. “The answer is virtually everything–annuities, traditional IRAs, 401(k)s, SEPs and 412(i) plans. Taken together, these assets can result in a significant income tax for clients. Also, many advisors fail to understand that Internal Revenue Code Section 691(c) permits a deduction for estate taxes paid on qualified plan money. But if there is no taxable estate, then Section 691(c) doesn’t come into play.”

Life insurance can be used to pay income tax on a conversion from a traditional IRA to a Roth IRA, distributions from which pass to beneficiaries income tax-free if all requirements are met. The unneeded RMDs are used, as in the earlier example, to pay the policy premiums. Depending on the estate value, insurance covering a surviving spouse’s life insurance can also pay off estate taxes, he explained.

The value of a policy will be all the greater come 2011, because income tax rates are due to rise then, said Johnson. The current rates, now 25%, 28%, 33% and 35%, will automatically change after 2010 to 28%, 31%, 36% and 39.6%, respectively, without Congressional action.

“So you need to be careful as to when you do a Roth conversion and pay income taxes,” said Johnson. “Tax rates aside, advisors should make life insurance part of the conversation process to help clients pass on as much of their qualified plan assets as possible.”

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