Individuals whose estates exceed the estate tax exemption often purchase life insurance, which can be used to pay the estate taxes due on their respective estates. The current federal exemption is $2,000,000, until January 1, 2009, when it will increase to $3,500,000. In 2010, the federal estate tax will be repealed in its entirety only to be reinstated in the year 2011.
If a decedent does not exhibit any “incidents of ownership” in a life insurance policy, then the insurance proceeds will not be includable in his/her taxable estate. Hence, the proceeds can be used to pay any estate taxes that are due. In order to avoid any incidents of ownership, the individual on whose life the policy is measured should not actually own the policy or pay any premiums on the policy. In addition, the individual cannot change the names of the beneficiaries. One way to accomplish the goal of excluding the life insurance proceeds from the estate is to transfer ownership of the policy to an irrevocable life insurance trust.
Typically, when an irrevocable life insurance trust is utilized, the individual who wishes to purchase the life insurance creates a trust. Such individual (the “Grantor”) appoints a trustee who purchases a life insurance policy on the Grantor’s life. The Grantor can name the ultimate beneficiaries of the policy in the actual trust agreement. Each year, when the premium on the policy is due, the Grantor makes a contribution to the trust. The transfer to the trust by the Grantor is subject to gift taxes because it is considered a gift of a “future interest,” (i.e., the right to receive insurance proceeds in the future) and not a gift of a present interest.
However, there is a way to get around this gift tax issue by making the gift qualify for the annual gift tax exclusion, and to deem the transfer to the trust a “present gift.” In order to effectuate that, a notice, known as a “Crummey” notice, is sent by the trustee annually to each respective beneficiary giving him/her the right to withdraw the amount transferred to the trust (i.e., the funds for the premium). This allows the payment to qualify for the annual exclusion ($13,000 per beneficiary per calendar year commencing in 2009). By issuing a Crummey notice, the trustee is effectively taking the gift of a future interest (which is not eligible for a gift tax exclusion) and making it into a gift of a present interest. Clearly, any beneficiary who actually requests a withdrawal of the funds, will no longer benefit from the far greater future gain of insurance proceeds.
If the insured does not survive for three years after transferring an existing life insurance policy into a life insurance trust, the proceeds will be included in his taxable estate. The three-year requirement does not apply when a trustee purchases a new policy. Accordingly, this is the more advisable way to proceed.
Individuals who purchase life insurance policies in order to pay their estate taxes must estimate the amount of insurance required. Typically, a life insurance advisor can compute that number based upon the current value of a person’s estate and actuarial tables. An experienced attorney should draft the trust according to
the client’s individual needs and advise
the client regarding gift and estate tax
consequences.
Ronald Fatoullah & Associates is highly recognized throughout the New York area for their expertise and outstanding services in the areas of elder law and estate planning. Ronald Fatoullah is proud to have been selected as one of New York Magazine’s “Best Lawyers” for three consecutive years in the fields of elder law, trusts & estates, and he is the legal advisor to this magazine. This article was written with the assistance of Stacy Meshnick, Esq., senior staff attorney and Medicaid supervisor at the firm.
To reach Ronald Fatoullah & Associates please call 718-261-1700 or 1-877-Elder Law.
