Generation-skipping trust (GST) planning has become more common over the last 20 years, as successful business owners, executives and wealthy individuals have enjoyed economic success.
Life insurance owned by a GST can offset large estate taxes due when the grandparent estate owner dies, providing significant financial leverage with income, estate and generation-skipping tax-free funding. This injection of insurance proceeds into the GST can provide a tax-free inheritance to the grandchildren while “skipping” estate taxes on the middle-generation children.
But, what if the first generation grandparent is uninsurable? Or rated so high as to make the premium unaffordable from a cash flow point of view? Or financially non-competitive from an internal rate of return (IRR) point of view? Is there a way to eventually restore asset value to the family, which will be lost to large federal and/or state estate taxes when the first generation grandparent dies? The answer is yes!
The first generation grandparent can be the grantor of a generation-skipping “estate restoration” irrevocable life insurance trust (ILIT) for the benefit of the third-generation grandchildren. The grantor can make annual gifts to this trust to fund premiums on the lives of the second-generation children. Eventually, the death proceeds will be income, estate, and generation-skipping tax-free to the ILIT for the benefit of the grandchildren.
If desired, a time value of money factor can also be assigned to the estate assets lost to taxes to determine the total death benefit that may be placed subject to the financial underwriting guideline limits of the carrier.
Case example: The grandparent is a female, age 85, who is uninsurable based on medical history. She has an estate of $10 million and is facing about $3 million in federal and/or state estate taxes. She wants to find a way to offset these taxes and restore this impending lost asset value to her family. Her son and daughter-in-law are both 60, and they have a significant estate of their own. There are three grandchildren in this family who would ultimately benefit from any multi-generation planning.
Solution and case design: Create a generation-skipping “estate restoration” ILIT where the remainder beneficiaries of the trust are the three grandchildren. The trust is authorized to purchase insurance on the lives of any direct descendents of the grantor and also authorizes direct descendents and trust beneficiaries to make their own contributions to the trust.
The trustee becomes the applicant, owner and beneficiary of a competitive 10-pay $3 million guaranteed no-lapse survivorship universal life (SUL) policy on the lives of the son and daughter-in-law (preferred non-smokers). The 85-year-old grantor makes annual premium gifts of about $65,000 per year for 10 years to the ILIT. (The trust has the usual Crummey withdrawal powers for children and Cristofani withdrawal powers for grandchildren.) The grantor also allocates gift-tax annual exclusions, applicable lifetime gift exemption and generation-skipping exemption on the Form 709 U.S. Gift Tax return.
Financial and tax considerations:
- The grantor allocates $14,000 gift tax annual exclusions (indexed), times five trust beneficiaries (son, daughter-in-law, three grandchildren), which adds up to $70,000 in annual exclusions available to offset annual premium gifts of $65,000. If the grantor wishes to make other annual exclusion cash gift directly to her heirs, then she can offset the $65,000 annual premium gifts by allocating some of the $5.25 million lifetime gift exemption (indexed) each year on the Form 709 Gift Tax return.
- The grantor also allocates $65,000 each year for 10 years against the $5.25 million generation-skipping exemption (indexed) on the Form 709 Gift Tax return.
- The IRR on the SUL death benefit at joint life expectancy (30 years) of the son and spouse is 6.12 percent. In a combined 35 percent income tax bracket, this is equal to a very competitive pre-tax equivalent IRR of 9.42 percent over the 30-year period of time.
If a time value of money (3 percent to 4 percent) factor is taken into account for financial underwriting purposes, the carrier could be asked to underwrite a larger survivorship SUL death benefit of about $6 million. This larger death benefit takes into account the fact that the restoration of lost estate taxes will not take place until some future year beyond the death of the 85-year-old grantor. The annual premium for a 10-pay no-lapse SUL with a $6 million death benefit would be approximately $130,000 with annual exclusions, lifetime gift exemption and generation-skipping exemption allocated accordingly on Form 709.
If the 85-year-old grantor dies before making all 10 annual gifts for premiums, then the second generation children can make the remaining gifts into the trust to complete the 10-pay no-lapse premium schedule.
In summary, the 85-year-old grandmother is making annual cash gifts to the trust for insurance on the joint lives of her son and daughter-in-law for the ultimate benefit of her three grandchildren. It will take a while, but the grandmother’s estate will eventually be restored for her family even though she was currently uninsurable.
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