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  Estate Planning


What is an estate? IRC Section 6166: A Deferred Payment Schedule
What is estate planning? IRC Section 2035
What is a will? Using Life Insurance to Preserve the Value Of Your Estate
What is a trust? The Basics of an Irrevocable Life Insurance Trust
What is an Irrevocable Trust? Using Split Dollar Funding in an Irrevocable Life Insurance Trust
What is the Marital Deduction Making sure Life Insurance Proceed stay "Tax Free"
The Charitable Deduction  

What is an estate?

An estate is the total property, real and personal, owned by an individual prior to distribution through a trust or will. Real property is real estate and personal property includes everything else, for example cars, household items, and bank accounts. Estate planning distributes the real and personal property to an individual's heirs.

What is estate planning?

Estate planning is the process by which an individual or family arranges the transfer of assets in anticipation of death. An estate plan aims to preserve the maximum amount of wealth possible for the intended beneficiaries and flexibility for the individual prior to death. A major concern for drafters of estate plans is Federal and state tax law.

What is a will?

A will is a legal document, created by you, that documents your plan for the distribution of your assets after your death. A will needs to be in writing and witnessed. Be sure to consult with an attorney.

What is a trust?

Generally, a trust is a right in property (real or personal) which is held in a fiduciary relationship by one party for the benefit of another. The trustee is the one who holds title to the trust property, and the beneficiary is the person who receives the

What is an Irrevocable Trust?

A trust that cannot be revoked or amended by the party who establishes it. This type of trust is often established when life insurance is purchased to protect an estate.

What is the Marital Deduction

For purposes of the federal transfer tax, you can - during your lifetime or at death give an unlimited amount of wealth to your spouse tax-free. While this is a nice benefit, unfortunately it will not last forever. Once the surviving spouse dies, his or her estate may be subject to estate taxes depending upon the value of the assets in the estate. Planning ahead to cover the cost of potential estate taxes is the best strategy. Survivorship insurance - sometimes referred to as second-to-die insurance can provide cash in the form of a death benefit that can be used to help pay estate taxes.

The Charitable Deduction

You can donate an unlimited amount of assets to a qualified charity free of estate and gift taxes.

IRC Section 6166: A Deferred Payment Schedule

The IRS created Section 6166 of the Internal Revenue Code because of the burden estate taxes place on business owners and their families. If your business qualifies, Section 6166 permits the executor of your estate to pay the portion of the estate tax attributable to your business in installments, as opposed to one lump sum. During the first four years, the executor of your estate may elect to only pay interest on the outstanding estate tax due. Thereafter, annual installments of both interest and principal are due for 10 years.

IRC Section 2035

Sec. 2035(a) generally requires that the gross estate of a decedent must include the value of any property in which the decedent has held an interest within three years of death. This includes property that the decedent has transferred by trust or any other means. It is important to avoid being subject to the three-year rule with regards to your life insurance. Many people use life insurance as an important estate planning tool by placing a policy in an irrevocable life insurance trust. To avoid being subject to IRC Section 2035 create the irrevocable life insurance trust and then have the trust apply for the life insurance policy instead of obtaining the policy first and then creating the trust.

Using Life Insurance to Preserve the Value Of Your Estate

Will you owe estate taxes? Only individuals and couples with larger estates may owe estate taxes. With proper estate planning, more of an estate's assets can be transferred to its heirs. Estate planning also includes a will or trust that provides instructions about how the estate is to be transferred and to whom. A will is a legal document, created by you, that documents your plan for the distribution of your assets after your death. A will needs to be in writing and witnessed. Be sure to consult with an attorney.

You can donate an unlimited amount to a qualified charity without estate or gift taxes.

You work a lifetime to accumulate assets. After your death you want your assets to be distributed to your heirs in accordance with your wishes. If your estate may be subject to federal estate taxes and state inheritance taxes, life insurance can provide the money necessary to pay these taxes and your final expenses.

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The Basics of an Irrevocable Life Insurance Trust

The irrevocable life insurance trust (ILIT) is used to remove the ownership and control of a life insurance policy from an estate. Life insurance can be used to fund estate taxes and final expenses upon the death of an individual. If a life insurance policy is not removed from the estate then the proceeds of the policy will increase the size of the estate even if the estate is not the beneficiary. For married couples, a Second-to-Die or Last Survivor Life Insurance policy can be used to insure both lives and provide death proceeds upon the death of the second spouse (when estate taxes would be due).

Ideally the ILIT would be set up before the life insurance policy is applied for. Then, the ILIT trustee would apply for the life insurance policy with the ILIT as the owner and beneficiary. If a life insurance policy is purchased before the ILIT is set up, the policyowner can gift the policy to the ILIT by changing the owner and beneficiary of the policy to the ILIT. If an existing life insurance policy is gifted to an ILIT, the policy will be subject to the three-year rule. The three-year rule states that if a death benefit is paid within three years of the transfer; then the proceeds will be included in the grantor's estate and, therefore, subject to estate taxes.

The ILIT's trustee pays the premiums for the life insurance policy, usually with gifts made to the ILIT by the grantors. Upon the death of the insured (second death in the case of a Second-to-Die or Last Survivor Life Insurance policy), the life insurance policy will pay its death proceeds to the ILIT. The trustee will then distribute the life insurance proceeds according the trust document's instructions. This type of arrangement is valuable because it can provide the liquidity and income to pay the estate taxes and final expenses without selling estate assets.

Using Split Dollar Funding in an Irrevocable Life Insurance Trust

For individuals or couples who have ownership in a corporation, using split dollar funding enables a corporation to pay for the premiums of the life insurance policy in an irrevocable life insurance trust (premium payments by the corporation are non-deductible). Under the contributory plan, which is the most common form of split dollar funding, the corporation pays the premium and the trust pays the corporation for a portion of the premium. The trust's portion is usually the lower of the P.S. 38 rate (government established rate on the lives of two people) or an insurance company's joint life one-year term life rate.

A split dollar agreement is established by the creation of an agreement between the grantors employer and the trust.

There are two different forms of split dollar agreements used depending on the grantors and spouses percentage of ownership in the corporation. A collateral assignment split dollar agreement is used if ownership in the corporation is less than 51% by the grantor and spouse. If ownership in the corporation by the grantor and spouse is 51% or more then a majority shareholder split dollar agreement is used. Upon the death of the second spouse (assuming a joint life insurance policy is used) the trust receives the death benefit of which a portion is used to pay back the corporation for the premiums it paid and the remainder can be used to pay for estate taxes and expenses.

Making sure Life Insurance Proceed stay "Tax Free"

While life insurance proceeds are income tax free to your beneficiary (ies), they are generally subject to estate taxes. This can be very problematic given the fact that one of the great benefits of life insurance is the liquidity and income replacement it provides a family subsequent to the loss of a loved one and that the level of coverage your premiums are purchasing may be reduced by as much as fifty percent (50%) by the federal estate tax, thereby depriving your loved ones of the very protection you intended to provide. For example, if a life insurance policy provides a death benefit of One Million Dollars ($1,000,000), but before those proceeds can be distributed to the beneficiaries, the estate tax bill associated with that policy must be paid, and the tax rate for that estate is forty percent (40%) (current estate tax rates range from thirty-seven percent (37%) to fifty percent (50%)), the death benefit that will reach the beneficiaries is only Six Hundred Thousand Dollars ($600,000). The result is that the protection you intended to provide for your beneficiaries does not amount to the protection they actually receive. Why does this happen and, more importantly, what you can do to avoid making this mistake?

The IRS states that any life insurance policies over which you have "incidents of ownership" (i.e. the right to change the beneficiary and to make other decisions with respect to the policy) will be included in your estate for estate tax purposes. Essentially, any life insurance policies you own will be included in your estate and will be subject to estate taxes upon your death. The question is this: Is it possible to ensure the right people receive the proceeds upon your death but avoid including those proceeds in your estate by changing the owner of the policy? The answer is yes!

The solution is to make sure that, while the life insurance proceeds will be distributed to the proper individuals, but that you do not retain the ownership rights associated with those life insurance policies which would cause the inclusion of those policies in your taxable estate and therefore would result in a dilution of the protection following the payment of estate taxes. This is accomplished through the use of an Irrevocable Life Insurance Trust (ILIT). You create an ILIT and name someone you trust as the Trustee (i.e. spouse, sibling, etc.). After the ILIT is created, you make the trust the beneficiary of the policy and you assign the ownership of the policy to the trustee. The ILIT will receive the proceeds upon your death and will hold those proceeds for the beneficiaries of the trust (which you chose when you created the trust). For example, your ILIT can provide that your surviving spouse will benefit from the proceeds during his/her life and upon his/her death, the remaining proceeds will be distributed to your children, as you intended when you named your spouse as the primary beneficiary and your children as the secondary beneficiaries.

This plan works because after you assign the ownership of the policy(ies) to the ILIT, you no longer have any ownership rights with respect to the policy(ies) and, therefore they will not be subject to estate taxes upon your death. The IRS allows for this planning, but requires that the assignment of the ownership of the policy(ies) take place at least three (3) years prior to your death for the transfer of the ownership to take effect. Consequently, this planning should be implemented as soon as possible so the "three year rule" will be satisfied.

The purposes of your life insurance coverage are no different, but the estate tax results could not be more different. Because the ILIT owns the policy, it will not be included in your estate and will not be subject to estate tax on your death. Consequently, the value of the policy is passed to your beneficiaries undiluted by the estate tax. Let's revisit the example from above: Without the planning, a One Million Dollar ($1,000,000) policy subject to a forty percent (40%) estate tax results in a realized benefit of Six Hundred Thousand Dollars ($600,000) to your beneficiaries. If an ILIT is used correctly, that same One Million Dollar ($1,000,000) policy will not be subject to estate taxes and the realized benefit to your beneficiaries will be the full One Million Dollars ($1,000,000). In a very real sense, this planning can and will save your loved ones hundreds of thousands of dollars.

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Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice.





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