revocable life insurance trusts chapter 35 tools & techniques of life insurance planning 35 - 1 ...

Revocable Life Insurance Trusts Chapter 35Tools & Techniques of Life

Insurance Planning

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What is a trust? Legal relationship that enables one party (the trustee) to hold money or other

property (the trust principal or corpus) transferred to the trust by a second party (the grantor) for the benefit of one or more third parties (the beneficiaries) according to the terms and conditions of the legal document (the trust agreement)

For investment, management, and administrative purposes, the trustee holds full legal title to the property in the trust

The trustee or trustees must use or distribute the property and income it produces for and to the beneficiaries selected by the grantor and named in the trust


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Living trust defined A trust set up during lifetime

Also called an “intervivos trust”

Trust can hold assets placed into trust by its creator during his lifetime

It could also accept additional assets at its creator’s death LITPOW – Life insurance trust pour-over will


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• What is a revocable life insurance trust?• Trust established during a client’s lifetime that can be revoked by the client

• Client specifically reserves the right at any time to alter or amend its terms or terminate the trust and recover its assets

• A revocable trust is generally irrevocable while the grantor is incompetent

• The policy owner reserves all of the ownership rights in the policies and will be responsible to pay all premiums

• If the policy is funded with income producing assets, the trustee usually will be required to use the income from those assets to keep the policy in force

• Life insurance policies are seldom transferred to a revocable trust• Cautious authorities suggest cash or some other asset be placed in the trust as well to

thwart an argument in a jurisdiction that may not clearly accept such a designation as adequate


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• What is a revocable life insurance trust? (cont'd)• A revocable trust can be named as a contingent beneficiary of policy proceeds

• In case the primary beneficiary dies before the insured, there would be a receptacle for the money

• By transferring a policy to a revocable trust, if the grantor become incapacitated, the trustee can borrow cash value from the policy to keep it in force

• Why should a client set up a trust?• Management

• Conservation

• Distribution


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• Why should a client set up a trust? (cont'd)• Postpone ownership during incapacity or inability of the beneficiary

• Where beneficiary is unable or unwilling to invest, manage, or handle the responsibility of an outright gift

• Maintain control over a beneficiary• Where the client wants to institute a gift program, but fears the possible results of an

outright no strings attached transfer

• Avoid fragmentation of the property• Where proposed gift property does not lend itself to fragmentation, but the client wants to

spread beneficial ownership among several people

• Retention over control of assets• For example, where the client wants to prevent the beneficiaries from disposing of the

property to persons outside the family


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• Why should a client set up a trust? (cont'd)• Unifying receptacle for other assets

• Bringing assets together may save administrative costs and avoid multiple probates where property is owned in more than one state

• Avoidance of publicity• Terms of the trust are not public knowledge

• For example, where client wants to disinherit a particular family member or name a friend who is not a family member as beneficiary

• Opportunity for a trial run• How well does the trustee manage the property?

• How well do the beneficiaries handle the income or other rights given to them?


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• Why should a client set up a trust? (cont'd)• Opportunity for a trial run (cont'd)

• Familiarizes trustee with client’s assets, family, plans, and relationships of each to the others. If the client doesn’t like what he see, changes can be made

• Selection of a favorable forum• Client can select a state where the laws are most favorable to accomplishing his

dispositive and administrative objectives

• Not necessary to use the laws of the client’s domicile state when creating a revocable trust

• Rule against perpetuities

• Allows the trust to continue longer than might be permitted otherwise

• Elective share


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• Why should a client set up a trust? (cont'd)• Selection of a favorable forum (cont'd)

• Will contests

• Trustee can use the assets of the trust to defend the trust against a challenger

• Creditor’s rights

• If transfer is made in avoidance of exiting or anticipated claims of creditors, it may be voided

• Charitable bequests

• Mortmain statutes – Limit gifts to charities if made within a specified period prior to death

• Restrictions on qualification to serve as executor


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• Why should a client set up a trust? (cont'd)• Equalize risk and potential for multiple beneficiaries

• Provide for ownership flexibility during beneficiary’s minority• Makes it possible to sell, exchange, or mortgage a minor’s property without the

expensive, inflexible, and troublesome process of appointing a guardian

• Assure dispositive objectives• Prevent assets from going to someone other than who the client intended

• Provide for the helpless• Physically, mentally, emotionally, and legally incompetent beneficiaries

• Relieve the overburdened


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• Why should a client set up a trust? (cont'd)• Back-up for the healthy

• Couple with a durable power of attorney, a revocable trust can provide the basis for a contingency plan to deal with the client’s inability to handle his own financial affairs

• Multi-state administration can be avoided• Placing out of state assets in a single revocable trust

• Reduce the risk of a successful challenge• Trust less likely to be broken than a will based on lack of capacity, or claim of fraud or

duress

• Trustee can use trust assets to defend against a party who disagrees with the terms of a will


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• Advantages of a revocable life insurance trust• Simple amendment to trust can achieve a redistribution of the proceeds of dozens of

policies• Saves client time and aggravation

• Life insurance proceeds will be immediately available for the trustee’s disposition

• Tax-free transactions• Transfer of a policy to the trust

• Designation of the trustee as the beneficiary

• Distribution of the proceeds to the trustee


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• Advantages of a revocable life insurance trust (cont'd)• Makes disposition of the policy easier when the beneficiary predeceases the insured

• Probate is avoided• With respect to policy held by or payable to a revocable trust that continues after the

beneficiary’s death

• Proceeds may be insulated from the claims of the grantor's creditors and the claims of the grantor’s surviving spouse through an attack on the will or election against the will

• Continues the privacy afforded through life insurance

• All of the client’s assets can be “poured over” into a revocable living trust• trust serves as a unifying receptacle for the collection of assets


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• Disadvantages of a revocable life insurance trust• Legal and accounting fees

• $500 to $5,000 or more to draft trust

• Filing of income tax returns may be required

• IRS form 1041, the Fiduciary Income Tax Return

• Trust’s income, deductions, and credits must be reported by the grantor

• Trustee commissions• May run as high a 1.5% to 2% of trust assets

• Hidden obstacles• Bank refuses to allow the mortgage to be carried over to the trust

• Will the client’s property and casualty company insure cars and homes owned by a trust?


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• Disadvantages of a revocable life insurance trust (cont'd)• Hidden obstacles (cont'd)

• Time and trouble to continually assign assets to the trust• Special forms must be completed

• Estate taxes• Insurance proceeds paid to the trust will be includable in the insured-grantor’s estate for

federal estate tax purposes and generation-skipping transfer tax purposes

• Panacea syndrome• Not a magic pill

• Does not solve all problems simply by creating the trust


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• Role of the trust document• Sometimes called the “Trust Indenture” or “Trust Agreement”

• Sets forth the agreement between parties

• Sets out:

• How assets are to be managed

• Who will receive income and capital from the trust

• How the trust income and capital is to be paid out

• When and under what circumstances the income and capital is to be paid to each beneficiary


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• What is the job of the trustee?• Safeguarding and investing assets in the trust

• Making payments as directed to the named beneficiaries

• Any natural person with legal capacity to hold title to property can be named as trustee

• Any corporation which is authorized by its charter or articles of incorporation to act as trustee and which meets relevant state law requirements can be named as trustee

• Unincorporated associations or partnerships cannot be named as trustees• They are not separate legal entities

• No limit to the number of trustees that can be named


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• Who can be the beneficiaries of a trust?• Primary beneficiaries

• First to receive distributions from the trust

• Remainderpersons

• Receive what remains when a trust terminates

• Beneficiaries must be an identifiable and definite class or group

• Rule against perpetuities

• Right to vest – lives in being plus 21 years

• Uniform Statutory Rule Against Perpetuities

• Flat 90 years since the creation of the interest


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• Selection of a trustee

• Willingness to serve and at what cost

• Experience with trust, financial, business, accounting, and tax matters

• Temperament and relationship with the beneficiaries

• Tax effects of serving as trustee• Can trustee serve without unanticipated and adverse income, gift or estate tax

consequences


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• Selection of a trustee (cont'd)• Doctrine of merger

• The trustee and beneficiary of the trust must not be identical

• Trust should never have the following:• One of two or more beneficiaries as sole trustee

• One of two or more trustees as sole beneficiary

• beneficiaries who are the same persons as the trustees

• Someone other than the grantor should be named as trustee


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• Estate tax implications• Trust assets will be in the grantor’s estate

• Because grantor has right to alter, amend, revoke, or terminate the trust (IRC Section 2038)

• Third party owner issues• IRS has unsuccessfully argued that a grantor had to include in his estate a policy on his

life, owned by and paid for by his spouse, where the proceeds were payable to the grantor’s revocable trust at his death

• However, the surviving spouse makes a gift to the other trust beneficiaries when the proceeds are paid to the trust

• And the trust will be includable in the surviving spouse’s estate if the surviving spouse retained a lifetime income interest in the trust


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• Estate tax implications (cont'd)• Providing estate liquidity

• trust document should provide that assets in the trust at the decedent-insured’s death can (or even must) be used:

• To pay the expenses, administrative costs, and taxes of the estate, and

• Of the surviving spouse’s estate if other funds are not available

• Revocable trust can save estate taxes through use as a nonmarital trust or marital trust

• Allocate a portion of the estate into a credit bypass shelter trust. An amount equal to the unified credit equivalent ($2,000,000 in 2008) could pass to it without tax.

• The balance could pass to the surviving spouse in a manner qualifying for the marital deduction


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• Gift Tax Implications• No gift until client gives up power to revoke

• Client has not parted with dominion and control of the assets placed into trust

• If and when the trust becomes irrevocable during the client’s lifetime, the client will be deemed to have made a gift at that time

• Value is based on the value at the time the client gives up dominion and control of the assets

• Third party payment of premiums is a gift

• Gift when policy owned by other than insured is paid to third party• Potential serious and adverse tax consequences when life insurance is owned by one party

on the life of another party and is payable to a third party


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• Income tax implications• No significant impact when assets transferred to a revocable trust

• Client must report trust income, losses, deductions, and credits as though they were personally incurred

• Holding period of the client is tacked onto the holding period of the trust for capital gain and loss purposes when an asset transferred to a revocable trust is sold

• But if the trust become irrevocable (such as at death or permanent incapacity of the grantor), a new holding period begins

• Potential income tax issues• S corporation stock problem

• If the trust becomes irrevocable, the stock must generally be transferred out of the trust within 2 years


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• Income tax implications (cont'd)• Potential income tax issues (cont'd)

• Professional corporation stock problem

• Most states allow only professionals to hold the stock of a professional corporation

• This may not include a revocable trust

• Section 1244 stock problem

• Loss on a sale by a revocable trust of closely held stock would be a capital rather than an ordinary loss

• Incentive stock option problem

• If options held by a trust, the tax advantages will be denied

• IRAs

• It may not be possible to roll over benefits tax free


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• Creditor implications• All states currently allow creditors access to any assets held in a trust which the

client can revoke or liberally amend

• Creditors of an estate generally have 4 to 6 months to press their claims• No such time limit exists for creditors of a trust

• Coordinating the revocable trust with the overall estate plan• Importance of a will

• Few clients will place all of their assets in a revocable trust

• Some assets will unintentionally pass through intestacy absent a will

• There are certain objectives that can only be accomplished by will

• Guardians for his children


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• Coordinating the revocable trust with the overall estate plan (cont'd)• Importance of a durable power of attorney

• Simple and inexpensive legal document

• Client gives a spouse, child, other relative, or trusted friend the legal right to act on his behalf and in his place with respect to financial matters

• Durable

• Power given is not affected by the client’s subsequent disability or incapacity

• A well drafted power may negate the need to petition the court to have a guardian or conservator appointed to handle assets during the client’s lifetime that have not already been placed into the revocable trust

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