PLANNING WITH LIFE INSURANCE TRUSTS First Run Broadcast: July 2, 2015 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Life insurance trusts are effective mechanisms for transferring wealth to a junior generation of a family in a highly tax-favored manner and providing liquidity after the settlor s death, whether to pay death taxes or for other purposes. These trusts involve the intricacies of choosing the right type of trust, defining Crummey powers in a way that permits the payment of insurance premiums, and assigning a value and defining terms in a way to avoid IRS scrutiny or defend an audit. When properly structured, life insurance trusts are highly effective in achieving client goals. When their inherent intricacies are overlooked or not properly drafted, these trusts expose clients and their larger estate plans to substantial IRS scrutiny and liability. This program will provide you with a practical guide to structuring and drafting life insurance trusts. Planning with life insurance trusts to transfer wealth, fund death taxes, and provide liquidity Types of life insurance trusts, including single-life and second death trusts Intricacies and traps of drafting the underlying trust and choosing the right policy Understanding the relationship of Crummey powers to pay ongoing insurance premiums Generation Skipping planning for life insurance trusts Counseling clients about tradeoffs of financial and tax benefits v. control in insurance trusts Speakers: David T. Leibell is Senior Wealth Strategist at UBS Private Wealth Management in New York City, where he provides clients comprehensive strategies to assist in the preservation, transfer and management of wealth. He also serves as an internal resource for UBS clients on all issues related to tax, estate planning, philanthropy and wealth planning. He is chairman of the Family Business Committee for Trusts and Estates Magazine and is listed in The Best Lawyers in America for two practice areas Trusts and Estates and Charities/Non Profits. Before joining UBS, he was a partner in the Private Client Services Department of Wiggin and Dana, LLP in Greenwich, Connecticut. Mr. Leibell received his B.A. from Trinity College and his J.D. from Fordham Law School. Daniel L. Daniels is a partner in the Greenwich, Connecticut office of Wiggin and Dana, LLP, where his practice focuses on representing business owners, corporate executives and other wealthy individuals and their families. A Fellow of the American College of Trust and Estate Counsel, he is listed in The Best Lawyers in America, and has been named by Worth magazine as one of the Top 100 Lawyers in the United States representing affluent individuals. Mr. Daniels is co-author of a monthly column in Trusts and Estates magazine. Mr. Daniels received his A.B., summa cum laude, from Dartmouth College and received his J.D., with honors, from Harvard Law School.
VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # E-Mail Address Planning with Life Insurance Trusts Teleseminar July 2, 2015 1:00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER June 25, 2015 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:
Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: July 2, 2015 Seminar Title: Location: Credits: Program Minutes: Planning with Life Insurance Trusts Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
PROFESSIONAL EDUCATION BROADCAST NETWORK Speaker Contact Information PLANNING WITH LIFE INSURANCE TRUSTS David T. Leibell UBS Private Wealth Management New York City (o) (212) 821-7063 david.leibell@ubs.com Daniel L. Daniels Wiggin & Dana, LLP - Greenwich, Connecticut (o) 203-363-7665 ddaniels@wiggin.com
Estate Planning with Life Insurance
What Is Life Insurance Defined: Contract in which insurance company ( Insurer ) promises to pay a specified amount ( Face Value ) to a designated person ( Beneficiary ) upon the death of the insured. 2015 Wiggin and Dana 1
What Is Life Insurance (cont d) Owner must have an insurable interest in the insured (avoids gambling) Owner has following powers: Power to name or change beneficiary Right to assign policy Right to cash value (if any) 2015 Wiggin and Dana 2
Uses of Insurance In Estate Planning Income replacement for spouse and descendants Providing liquidity to pay estate taxes Providing liquidity to fund buy-sell agreements Equalizing distributions for: Business interests (where not all children are in the business) Second marriage Investment Vehicle Cash value for retirement or disability Employee benefit 2015 Wiggin and Dana 3
Types of Life Insurance Term Pure insurance, no cash value Increasing premiums or level premiums Whole Life Level premiums Death benefit guaranteed by Insurer Cash value (sometimes dividends) Universal Life Term insurance plus savings account Typically death benefit is not guaranteed New guaranteed universal life 2015 Wiggin and Dana 4
Types of Life Insurance (cont d) Variable Life Term insurance plus investment account Second to Die Split dollar Not a type of insurance An arrangement where premiums and death benefit are allocated between two parties Typically Employees (employee but sometimes family) 2015 Wiggin and Dana 5
Tax Consequences of Life Insurance Income tax consequences to policy owner Policy cash value grows tax-deferred Withdrawals up to basis Loans above basis Possible gain on surrender of policy Income tax consequences to Beneficiary Proceeds received income tax free Exception: transfer for value rule 2015 Wiggin and Dana 6
Tax Consequences of Life Insurance (cont d) Estate tax consequences Subject to estate tax if: Policy is payable to insured s estate Insured owned any incidents of ownership at death Ownership of existing policy transferred within three years of insured s death Not subject to estate tax if purchased by Trustee of properly structured life insurance trust 2015 Wiggin and Dana 7
Life Insurance Trusts Lifetime transfer of ownership Guaranteed growth on investment Well suited for annual exclusion trust Tax savings = 40% of insurance proceeds Single life or second-to-die 2015 Wiggin and Dana 8
Life Insurance Trusts: Tips, Tricks and Traps Defining the terms spouse and descendants Marital disposition savings clause for 3-year rule Trustee disabling clauses Trustee removal powers Grantor trust status Designing the Crummey clause GST issues To allocate or not to allocate GST exemption? Dealing with the automatic allocation rules Discretionary grant of general power of appointment 2015 Wiggin and Dana 9
ab Advanced Planning Insights Life Insurance Planning Life insurance does something that no other asset can do provide instant liquidity at a time of great need. Advice. Beyond investing. Your financial life encompasses much more than the current markets. It includes your goals for the future and how you want to live right now. We are committed to addressing your needs giving you the confidence to pursue all of life s goals. Our comprehensive approach offers insight into life insurance planning techniques that may help meet the future needs of your family and business. What is Life Insurance 2 Types of Life Insurance 2 Estate Taxation of Life Insurance 3 Irrevocable Life Insurance Trusts 4 Conclusion 6 Advice. Beyond investing. plan access save borrow grow protect give
Life insurance plays a crucial role in many estate plans. Whether the purpose of the insurance is to replace the income of a deceased loved one or to provide liquidity to pay estate taxes in order to preserve a family business, life insurance does something that no other asset can do provide instant liquidity at a time of great need. In addition, if the life insurance is owned by a properly structured irrevocable trust, in most cases the insurance will not be included in the decedent s taxable estate. What is life insurance Fundamentally, the purchase of a life insurance contract involves an agreement with a life insurance company whereby in exchange for premium payments, the life insurance company will pay a death benefit to one or more beneficiaries upon the death of the insured. The insurance can either be term (guaranteed between five and thirty years), or permanent (designed to provide coverage for the insured s entire life). Some permanent insurance builds up tax deferred cash values that can be withdrawn, if necessary, in a tax efficient manner. Permanent insurance typically provides both a death benefit and a cash accumulation account. Types of life insurance Both term and permanent insurance are utilized in effective estate planning. The goal of term insurance is to provide liquidity and income replacement for one s family or liquidity to purchase a deceased shareholder s shares in a business should a business owner die prematurely. For those individuals looking to use insurance to provide liquidity to pay estate taxes, term insurance is the least appropriate form of life insurance because it is structured to end before the individual s life expectancy. So, if an individual lives their full life expectancy, there will be no insurance to pay taxes. Term insurance (which is typically the least expensive of all of the types of life insurance) can either be purchased as an individual policy or can be provided under a group policy (typically for employees). And unlike permanent insurance, term insurance does not build up any cash value. In this way it is considered pure protection. Permanent life insurance, on the other hand, is the most appropriate form of life insurance to provide liquidity to pay estate tax. As its name reflects, permanent life insurance is expected to be in effect when the insured dies. Having said that, it is important to note that underfunded permanent life insurance (typically universal life or variable life), may not have sufficient assets to pay the cost of insurance and may lapse before an insured s death. A key difference between term insurance and permanent insurance is that term insurance provides only a death benefit while permanent insurance typically provides both a death benefit and a cash accumulation account. This cash value is accessible to the owner of the policy during the insured s lifetime for withdrawal in a tax-efficient manner. Permanent life insurance comes in a wide variety of choices and prices depending on the nature of the cash accumulation account and the nature of the guarantees provided in the particular policy by the issuing life insurance company. Whole life insurance is the most traditional form of permanent life insurance as well as the most expensive. If an insured pays the required premiums, the insurance company is contractually obligated to pay the death benefit. It s this guarantee that makes whole life insurance the most expensive. Whole life policies build up cash values that are invested in the insurance company s general account. Whole life policies sometimes pay dividends, which help to build up the policy s cash value over time. Advanced Planning Insights October 2014 2
Universal life is a form of permanent life insurance with fewer guarantees; it was developed as a response to the higher cost of whole life insurance. In a typical universal life policy, there s an insurance account and a cash accumulation account that is credited with monthly interest based upon the insurance company s current crediting rate. There is a target premium set at the time the insurance is purchased, but the policy owner is not required to make the target premium payment. In addition, even if the target premium is paid every year, the assumed interest crediting rates fluctuates with the market, and if interest rates go down over time, the owner will either need to pay a higher premium to keep the policy in place or let the policy lapse. Due to the risk of a universal life policy lapsing, particularly in a situation where a death benefit is necessary but the cost of whole life insurance is prohibitive, in recent years many insurance companies have created a form of universal life, known as guaranteed universal life, that reduces the emphasis on cash value growth in exchange for death benefit guarantees. This product has become extremely popular in the estate planning context where the need for cash value is less important than the need for a guaranteed death benefit. A variable life policy gives the owner the ability to allocate the investment account among a variety of mutual funds. Indexed universal life insurance allows the policy owner to periodically allocate cash value amounts to either a fixed account or one or more accounts linked to designated equity indexes, such as the index for the S&P 500. These policies usually guarantee a minimum return for the fixed account, but cap the maximum return that a policy owner can receive from the indexed accounts. The final type of permanent life insurance is variable life insurance. Variable life insurance was developed in response to the tremendous returns generated by equities in the 1980 s and 1990 s. Like traditional universal life, variable life has two separate accounts, an insurance account and an investment account. But unlike universal life, in which the investment account is invested conservatively in money markets and treasuries, a variable life policy gives the owner the ability to choose to allocate the investment account among a variety of mutual funds, some of which invest in equities. In a growth market, the idea works well. However, in a down market (like 2008-2009), this product can be challenging because the investment account may not be able to keep pace with the increasing cost of insurance, and the owner will either have to pay significantly more in premiums or let the policy lapse. Estate taxation of life insurance There is some confusion over the estate taxation of life insurance. That is because many people think that because life insurance proceeds are not subject to income tax that they are also not subject to estate tax. Unfortunately, this is not true and, unless structured properly, life insurance owned by a decedent will be included in the decedent s estate upon death. Under Internal Revenue Code ( IRC ) Section 2042, life insurance proceeds are included in a decedent s gross estate (i) to the extent of the amount received by the executor on policies on the life of the decedent; plus (ii) to the extent of the amount receivable by all other beneficiaries as insurance on the life of the decedent from policies over which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person. In addition, even if the insurance proceeds are not includable in the decedent s estate because they are outside the scope of IRC Section 2042, such proceeds can still be includible Advanced Planning Insights October 2014 3
in the gross estate of the decedent under some other section of the IRC. For example, if the decedent possessed incidents of ownership in an insurance policy on the decedent s life, but gratuitously transferred all rights in the policy within three years of death, the proceeds would be includible in the decedent s taxable estate under IRC Section 2035. If an individual transfers an existing policy to an irrevocable trust, he or she must live more than three years from the date of transfer in order for the life insurance proceeds to be out of the taxable estate. Irrevocable life insurance trusts Since life insurance owned by a decedent or payable to the estate is includible in the decedent s taxable estate, one of the premises of estate planning is to transfer any life insurance owned by an individual whose assets exceed the estate tax exemption ($5,340,000 in 2014) to an irrevocable life insurance trust (or ILIT ) in order to remove the life insurance proceeds from the individual s taxable estate. It must be remembered that even if all of the incidents of ownership are transferred to the ILIT, thereby satisfying the requirements of Code Section 2042, if the transfer was made within three years of the transferor s death, the proceeds will be brought back into the estate under Code Section 2035. So if an individual transfers an existing policy to an irrevocable trust, he or she must live more than three years from the date of transfer in order for the life insurance proceeds to be out of the taxable estate. If, however, rather than transferring an existing policy, the ILIT trustee purchases a new policy owned by the trust, the life insurance is out of the individual s estate from day one. It is also important to note that the transfer of an existing life insurance policy to an ILIT will have gift tax consequences to the transferor. As is the case with all gifts, the value for gift tax purposes of a life insurance policy is its fair market value as of the date of the gift. The value of the gift for gift tax purposes will differ depending on the type of policy. If the policy is a new policy, then the value of the gift is the cost of the contract. If the policy is either a single premium policy or a policy where all necessary premiums have been paid (a paid-up policy), the value of the gift is the amount that the insurance company would charge for the same type of policy if it was purchased by the insured as of the date of the gift. If, as is most typical, the policy is not new and continuing premium payments are required as of the date of the gift (the policy is not paid-up), then the value of the gift is the interpolated terminal reserve (a value provided by the insurance company and typically close in value to the policy s cash value) plus the unearned premium. Such gifts of existing life insurance policies to the ILIT should qualify for the current $14,000 annual exclusion, and any values exceeding the annual exclusion would either be covered by the $5,340,000 lifetime exemption or be subject to gift tax at a 40% federal tax rate in 2014. In addition to gift tax issues arising out of the transfer of an existing life insurance policy to an ILIT, there are also gift tax issues regarding ongoing transfers to the trust in order to pay premiums and whether such transfers qualify for the $14,000 annual exclusion. In order for a gift to qualify for the annual exclusion, the gift must be of a present interest; that is, according to the Treasury Regulations, the recipient must have an unrestricted right to the immediate use, possession, or enjoyment of property. 1 A transfer to an irrevocable trust is typically considered a gift of a future interest that does not qualify for the annual exclusion. That is where Mr. Crummey comes in. His lawyer came up with a concept that turns contributions to the ILIT to pay premiums into a present interest qualifying for the annual exclusion. He did this by giving the beneficiaries Advanced Planning Insights October 2014 4
the right to withdraw amounts that were contributed to the trust for a specified period of time after the amounts were contributed. Fortunately the Ninth Circuit agreed and the IRS acquiesced, and thus was born the Crummey Power. 2 Such withdrawal powers are set forth in the trust instrument. Typically, although not always, the beneficiary receives an annual letter, known as a Crummey letter, whereby the beneficiary is informed of the contribution and the right to withdraw for a period of time. If the beneficiary elects not to withdraw, the contribution stays in the trust to pay premiums and the contribution qualifies for the annual exclusion. In order to obtain the estate tax benefits, ILITs need to be irrevocable and set up during the grantor s lifetime. There are two basic types of ILITs single life insurance trusts and secondto-die insurance trusts. In order to obtain the estate tax benefits, both trusts need to be irrevocable and set up during the grantor s lifetime. ILITs can also be set up to be generation-skipping and can be an effective way to leverage the generation-skipping transfer tax exemption. In a typical single life ILIT, one spouse sets up an irrevocable trust and either funds it with an existing policy on his or her life (beware of the three-year look back) or has the trustee purchase a new policy on his or her life (out of the estate from day one). The insured spouse should not be the trustee, but the beneficiary-spouse can be the trustee as long as principal distributions are limited to an ascertainable standard. Typically, the noninsured spouse and descendants would be the beneficiaries. As long as life insurance is owned by the trust, the trust would be a grantor trust for income tax purposes, requiring the insured/grantor spouse to remain liable for any trust income taxes during life. A second-to-die ILIT is typically established as a mechanism for providing liquidity to pay estate taxes. Typically, both spouses are grantors and the trust is funded with a new policy on both lives, which pays out at the death of the survivor, when estate taxes are typically due. The trust includes language permitting, but under no circumstance requiring, the trustee to lend funds to the survivor s estate or to purchase assets from the survivor s estate in order to provide liquidity to pay estate taxes. Many times ILITs are used in the context of family business succession planning. Business owners estates are inherently illiquid, with the business and the business real estate often representing the lion s share of the value of the estate. Family business owners are often good candidates for life insurance owned by an ILIT, which can provide instant liquidity at the business owner s death to pay estate taxes, provide for children who are not active in the business, fund a buy-sell agreement, and provide for a spouse from a second marriage. Paying for the life insurance in the business owner context depends on who owns the policy. If the insurance is owned by the other shareholders or the corporation in the context of a buy-sell agreement, there should be no gift tax consequences on paying premiums. Sometimes the insurance ownership is bifurcated between the business owner and the corporation or between the business owner and certain family trusts. This bifurcated ownership is knows as split-dollar, and it s crucial that the business owner work with an attorney and an insurance professional who are both highly experienced in the area of split-dollar planning, since it is filled with tax traps. Advanced Planning Insights October 2014 5
Conclusion Life insurance can be a powerful planning tool. When properly integrated into an estate plan (often involving an ILIT), life insurance can provide liquidity to cash-strapped but taxable estates; fund gifting vehicles to benefit subsequent generations; and equalize inheritance allocations among descendants where a closely held business accounts for the lion s share of a person s legacy. Clients should speak with their financial and legal advisors to evaluate their existing policies and ensure that their goals are adequately addressed. David Leibell Senior Wealth Strategist The Advanced Planning Group of UBS provides comprehensive planning advice and education to ultra high net worth individuals and families. The team consists of professionals with advanced degrees, extensive planning experience and various areas of expertise. Through our publications, the Advanced Planning Group features the intellectual capital of UBS in wealth planning, estate tax and philanthropy and evaluates how changes in the legislative and tax landscape might impact our clients planning. 1 Treas. Regs. Section 25.2503-3(b) 2 Crummey v. Commissioner, 397 F.2d 82 (9th Cr. 1968); Revenue Ruling73-405. Advanced Planning Insights October 2014 6
This article provides general information on the topic discussed and is not intended as a basis for decisions in specific situations. Because of the complexities involved with developing estate and tax planning strategies, experienced legal and tax counsel should be consulted before implementing a strategy. UBS Financial Services and its affiliates do not provide legal or tax advice. Clients should consult with their legal and tax advisors regarding their personal circumstances. Important information about Advisory & Brokerage Services and financial planning services As a firm providing wealth management services to clients, UBS is registered with the U.S. Securities and Exchange Commission (SEC) as an investment adviser and a broker-dealer, offering both investment advisory and brokerage services. Advisory services and brokerage services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. It is important that you carefully read the agreements and disclosures UBS provides to you about the products or services offered. For more information, please visit our website at ubs.com/workingwithus. 140128-0141-009_S We offer both investment advisory and brokerage services, each of which is separate and distinct, differs in material ways, and is governed by different laws and separate contracts. We offer financial planning as an investment advisory service. This service terminates when the plan is delivered to the client. Note that financial planning does not alter or modify in any way the nature of a client s UBS accounts, their rights and our obligations relating to these accounts or the terms and conditions of any UBS account agreement in effect during or after the financial planning service. Clients are not required to establish accounts, purchase products or otherwise transact business with us to implement any of the suggestions made in the financial plan. Should a client decide to implement their financial plan with us, we will act as either a broker-dealer or an investment adviser, depending on the service selected. We provide financial planning services as an investment adviser for a separate fee pursuant to a written agreement, which details the terms, conditions, fee and scope of the engagement. For information about our fee-based financial planning services, see the firm s Financial Planning ADV Disclosure Brochure. Insurance products are made available by UBS Financial Services Inc. Insurance Agency or other insurance licensed subsidiaries of UBS Financial Services Inc. through third-party unaffiliated insurance companies. UBS 2014. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved. UBS Financial Services Inc. is a subsidiary of UBS AG. Member FINRA/SIPC.