With the economic and legal turmoil of the past decade, numerous advisors have encountered clients with the following unfortunate story:
Martha is 76 years old. Her husband of 50 years, Frank, passed away six months ago. Eleven years ago, Frank and Martha created an irrevocable life insurance trust (ILIT) which purchased a $2 million survivorship universal life insurance policy. Martha has just been notified by the trustee that the annual premium of $30,000 is due.
The policy has almost no cash value. If the premium is not paid in a timely manner, the policy will lapse. In 2002, when the trust was created, the unified credit for estate taxes was $1 million per individual, and this same unified credit level was scheduled to apply from 2011 forward after sunset of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
In 2002, Frank and Martha’s combined net worth was nearly $4 million and growing. However, the couple lost a substantial portion of their net worth during the market collapse of 2008 and the following recession. Additionally, Frank’s end of life medical care resulted in large medical bills. Martha is now in a dramatically different financial position than she and her husband were in 2002. Also, the unified credit is now $5.34 million per person (2014) and $10.68 million per couple. Hence, exposure to federal estate taxes is no longer an issue for Martha.
Martha is considering discontinuing the annual gift to the trust to pay the premium. Martha is concerned about maintaining her standard of living, and without a need for liquidity to pay estate taxes she sees little point in continuing the policy. She is frustrated that more than a quarter of a million dollars has been paid for a policy that may lapse, and she is distressed that the planned legacy for her family will be diminished.
The story of Martha and Frank is not unlike the story of many couples who try to gauge their exposure to estate taxes. They understand that the federal exemption to the tax has been, and will continue to be, a moving target. Additionally, they know that for a middle aged healthy couple there is a good chance that at least one of them will still be living decades from now.
Placing substantial funds in an irrevocable technique for what may be a long period of time is understandably bothersome to many couples. For such clients, a technique has been developed that allows for the delay of irrevocable decision-making until the first of their deaths. This technique involves the purchase of survivor purchase options (or SPOs) as riders on permanent cash-value, single-life policies.