Incredibly versatile, life insurance has a lot to offer in the estate planning world. This is especially true in light of its tax advantages, which include income-tax deferred growth, income tax-free death benefit and the potential for an estate tax-free death benefit if the decedent does not own the life insurance policy, or owned the policy and transferred it to another owner more than three years prior to death.

Because of these benefits, it is important that life insurance agents understand how their product can play a vital role in estate preservation. Equally important, we must keep abreast of current laws involving estate taxes. This is especially true given the 2010 debate over the anticipated sunset of the “Bush tax cuts” and the continued uncertainty with regard to long-term estate tax issues.

Legislative overview

Late last year, Congress extended Bush’s estate tax provisions for an additional two years, as part of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. This legislation includes several elements that could impact clients as they make estate planning decisions:

  • Top rate reduced to 35 percent: The bill imposes a top tax rate of 35 percent, which is reduced from the 2009 top rate of 45 percent.
  • Reunification of the Estate and Gift Taxes: The proposal reunifies the estate and gift taxes, effective for gifts made after Dec. 31, 2010.
  • Increased exemptions: The bill set the exemption level at $5 million per person and $10 million per couple for the estate, tax and generation-skipping transfer taxes for two years, through 2012. The previous maximum (in 2009) was $3.5 million per person.
  • Portability of unused exemption: Under the law as it existed in 2009, in order to take full advantage of a married couple’s combined $7 million estate tax exemption, the first spouse’s exemption amount was generally held in a “credit shelter” or “bypass trust,” thus complicating ownership arrangements and legal documents. The new legislation allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without creating a trust. (The technical name for this is the Deceased Spousal Unused Exemption Amount). The portability provision applies only with respect to “the last such deceased spouse of the surviving spouse,” thus eliminating the possibility of accumulating exclusion amounts from serial marriages.

What happens next?
A key point to remember is that these provisions have only been extended through 2012, so as we approach the start of that year, clients may or may not receive additional clarity around the direction that estate taxes may take beyond 2012. As you work with them to make plans for anticipated estate tax needs, there will be many options to consider.

One option is to cash in savings accounts, checking accounts or certificates of deposit; however, these options are often insufficient. In some cases, the executor may borrow against assets in the estate, but practically speaking, this option also has its drawbacks. Generally, an executor cannot obtain a loan without incurring personal liability for the debt, unless the will specifically provides that the executor may do so. In addition, borrowing only defers the problem as the loan will eventually need to be paid back with interest. Selling estate assets could be another option. However, if the sale is rushed, the true value of the assets may not be realized.

Life insurance solutions
A popular life insurance option that clients may utilize to address their estate liquidity needs is a survivorship life insurance policy (SUL) that is owned by an irrevocable life insurance trust (ILIT). The survivorship policy pays a death benefit upon the death of the second spouse, creating funds for estate taxes when they are needed. The ILIT owns the policy, so that the decedent does not have ownership of the policy at death. While this option can create funding for estate taxes, its biggest drawback is inflexibility. Once the ILIT is established it cannot be changed, amended or revoked. If circumstances change in the future, the plan cannot be changed to address these issues.

Another option that may provide greater flexibility without sacrificing liquidity could be the use of a survivor purchase option (SPO) rider in conjunction with a whole life policy. This rider provides an insured beneficiary with options at the death of the base policy insured. The insured beneficiary might then choose to purchase a new policy at an attained age basis with ongoing premiums or a new policy on an original age basis. In addition, the beneficiary could opt for a single-premium paid-up policy.

Each of these three options can be funded using the death benefit that would be paid from the original insured’s policy. Of course, circumstances can change over time, and the insured beneficiary may decide that he or she does not need a new policy for estate liquidity. Likewise, the beneficiary may determine that he or she needs more or less insurance coverage based on changes to the size of the estate. If this is the case, the insured beneficiary can choose to simply spend the death benefit.

Clients have many options when it comes to generating funds needed at death, and each of these should be considered carefully as they make plans to address anticipated estate liquidity needs. One caveat: Remember that consultation with your client’s tax and legal advisors is most important before settling on an estate plan. This is the best way to ensure that their desires are adequately met.

Gregory A. Purvis, JD, CLU, ChFC, is assistant vice president in the advanced sales marketing department for American United Life Insurance Company, a OneAmerica Company.

For more exclusive life insurance coverage, visit ASJ’s Life Insurance Resource Center.

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