- Continue the life insurance in force as a diversification of the client’s investment plan. While many clients will sneer at the rates of return on an insurance policy the fact is that the average individual investor has earned about 2.2% on his or her investment portfolio per year over the last 20 years.
- For some clients having a conservative insurance product included in their overall investment plan may provide ballast to an otherwise risky overall investment strategy.
- Maintain the life insurance in force to pay for state estate taxes.
- Maintain the life insurance in force to pay for the capital gains tax cost associated with assets that have been gifted out of the estate.
- Consider that it may prove more advantageous to retain a highly appreciated/appreciating asset in the client’s estate, e.g., rental real estate, and instead grow insurance outside the estate. Insurance will not generally have any negative income tax consequence to its receipt and will not need a step-up in tax basis to achieve that favorable income tax result. In contrast, a family business or other asset unless held in the estate until death. Thus, it might be preferable to retain assets for step-up purposes in the estate instead of shifting those assets using note sales, GRATs and other techniques out of the estate. Then use a traditional insurance plan (permanent insurance held in an insurance trust) to pay any estate tax due.
- Does anyone really know what Washington might do next with the estate tax? It is possible (even if most tax experts view it unlikely) that the current $5 inflation adjusted exemption will be about as permanent as most things in Washington. Thus, retaining insurance that might be a reasonable investment to address the potential for adverse estate tax law changes in the future, may not be an unreasonable course of action.
- Before anyone ever cancels a life insurance policy the insured client should evaluate his or her current health status. If a policy was purchased when the client was in peak health and now years later the client might only qualify for a more costly rated policy, perhaps there is merit to retaining the existing policy even if it no longer serves its initial purpose (e.g., to pay an estate tax).
- If the policy really is no longer necessary for the client’s circumstances, before the policy is cancelled all possible alternatives should be considered. The policy might be exchanged in a tax free IRC Sec. 1035 exchange for a different policy or an annuity that serves the clients current needs better. The policy might be saleable into the secondary market for a profit. The policy might be useful to donate as part of a charitable plan. The policy might be converted into a paid up policy at a lower death benefit structured so no further premiums need to be paid.
- For married clients that have created non-reciprocal spousal lifetime access trusts (“SLATs”) as part of their estate plan, having life insurance on a spouse can be useful to mitigate the risk of premature death of that spouse which would cut off the surviving spouse’s access to the his or her own SLAT through the now deceased spouse.
- The trustee might be at risk for a lawsuit by beneficiaries for cancelling a policy, especially if there is no prudent independent analysis supporting that decision.
- Insurance might be useful to achieving classic insurance planning goals such as creating an estate, addressing the risk of premature death, etc.
- Whether or not a client is concerned about estate tax, the asset protection benefits of an irrevocable life insurance trust might be substantial. In many cases the insurance trusts the clients have or may cancel have been in place many years. The gifts to that trust may have been made over many years in annual increments none of which pose a risk of a fraudulent conveyance.
- The trust may have had lifetime gift tax exemption or generation skipping transfer (“GST”) tax exemption allocated to it so that terminating the trust might thus waste/lose that exemption amount.
- The distributee may be at risk for a malpractice or other claim thus putting the cash or other assets distributed out of the trust in jeopardy.
- The trustee might be at risk for a lawsuit by beneficiaries for making a distribution to one beneficiary, e.g., the spouse, and not to other beneficiaries, e.g., children from a prior marriage.
- Decant the trust into a new trust that better achieves current client objectives.
- The existing (old) insurance trust might be useful in a new plan by loaning funds to, or guaranteeing loans by, other family trusts thereby supporting other more significant current estate, asset protection or other plans.
Termination of an Insurance Trust the Client no Longer Wants – What Considerations, Steps, and Tax Implications?
“I don’t need life insurance because of the high estate tax exemption so I cancelled my policies and distributed the cash in my trust to my spouse.”
Far too many clients have chanted the same ill-planned mantra when queried about the status of their life insurance at an estate planning update meeting. In many cases the decision is made and implemented by the client without any input from professional advisers. Practitioners should proactively bring up this topic with all clients and engage in a dialogue about the status of any life insurance and insurance trusts so that a more reasoned analysis can be undertaken so clients do not cancel valuable coverage unless it is really advisable.
The estate tax exemption has been made permanent at a $5 million inflation adjusted amount. In 2015 a married couple can bequeath $10,860,000 without any federal estate tax. As a result, the knee jerk of many clients that they no longer need life insurance to pay an estate tax will in most instances be correct. However, cancelling coverage and terminating an irrevocable trust that held that insurance, can be less than optimal planning in some instances, and an invitation for the trustee to be sued.
Life Insurance Considerations
Whatever the ultimate decision, more factors should be addressed then merely the change in a federal estate tax exemption. Practitioners can assist clients questioning the continued relevance of a life insurance policy and a trust owning it in evaluating all relevant factors. These might include:
While cancelling a life insurance might be a reasonable step, in many cases there are other options that might just prove more advantageous. Too often clients seize on the simplistic analysis of “I’m no longer subject to an estate tax, so therefore I don’t need any life insurance” without considering the myriad of options including those listed above.
Irrevocable Life Insurance Trust (ILIT) Considerations
Whatever decision the client makes with respect to the life insurance if that insurance is held in a trust a decision as to whether that trust should be retained should be separately evaluated when appropriate. Most clients tend to view the life insurance and the trust holding the policy as one and the same. That view could lead to less than optimal decision making. For example, assume a client has a permanent life insurance policy held inside an insurance trust and has no need for the coverage, and the policy is not performing well. Assume after analysis by a life insurance consultant the determination is made to cancel the policy and surrender it for its cash value. Most clients that have determined on their own, without professional guidance, to terminate a policy will typically have the proceeds of that policy distributed out of the trust to the named heirs (e.g. the spouse, or in a survivorship policy the children). That second step may be a mistake even if the first step of cancelling the policy is reasonable. Consider the separate potential benefits and options for the insurance trust:
Too often clients make decisions concerning prior estate planning without understanding the full ramifications and opportunities to repurpose that planning in the new tax environment. Practitioners should proactively reach out to clients to educate them on the options available for existing life insurance and insurance trusts.
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