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The Roman scholar Pliny "the Elder" once observed that, "the only certainty is that there is nothing certain."
He must have been talking about the federal estate tax.
The estate tax has been repealed for one year only, 2010, and will be reinstated in 2011 unless the U.S. Congress and the President agree to a permanent repeal. With five congressional elections and two presidential elections between now and 2011, few people are willing to bet the ranch on even a one-year repeal–never mind a permanent rollback.
So, what are you supposed to tell your clients? How can you possibly plan for a tax and political environment that can shift as quickly as a mudslide? You and your clients can take precautions against getting buried by any fallout from Washington, D.C. by building as much flexibility into your estate plans as possible.
The biggest concern many clients have about moving ahead with their estate plans is the commitment of significant financial resources–particularly the purchase of large life insurance policies needed to create estate liquidity–to preserve their wealth for loved ones. Theyre reluctant to relinquish control over significant assets for estate liquidity, especially if they think the estate tax may eventually evaporate.
One solution that many financial professionals and their clients have found effective is the shared ownership of life insurance. The concept of shared ownership addresses the competing objectives of (i) wealth creation and preservation through estate-tax-free ownership of a life insurance policy; and (ii) access to the cash value of such policy. Based on state property and insurance law, as well as federal transfer tax law, shared ownership is increasingly being accepted as a mainstream estate and life insurance planning strategy.
For many people, the most efficient way to preserve an estate from estate taxation is to purchase cash value life insurance as part of an irrevocable life insurance trust (ILIT) and use the death benefit proceeds to pay estate taxes. This strategy has traditionally proved to be highly effective, especially when you consider that federal estate taxes can run as high as 50% this year before being "scaled back" to 45% by 2007, and returning to a high of 55% in 2011.
While the use of a trust without shared ownership protects the life insurance policys death benefit from estate taxes, it precludes clients from tapping policy cash values to supplement their retirement needs through income-tax-free loans or withdrawals.
The inflexibility of an irrevocable life insurance trust serves to reduce or eliminate a valuable source of cash for retirement or other financial needs. Consequently, using life insurance to supplement retirement income typically requires the policys death benefit to be included in the insureds gross estate and, therefore, triggers an estate tax liability on the insurance.
Sharing the ownership of the life insurance policy knocks down those barriers by establishing one life insurance policy with two owners who share the rights, costs and values of the policy. Often, the co-owners are the insureds spouse and an ILIT, the trustee and a beneficiary of which may be the insureds spouse.
In such a scenario, an ILIT typically realizes an income tax and estate-tax-free death benefit while the insureds spouse gains income-tax-free access to policy cash values through withdrawals and loans. Of course, this arrangement assumes the policy is not a modified endowment contract (MEC) and remains in force.
In establishing a shared ownership arrangement, an agreement is created between a "residual" owner and an "equity" owner at the time the life insurance is sold. The residual owner (e.g., an ILIT), receives the risk portion of the death benefit and pays the cost of that insurance coverage. To cover future costs of the risk protection provided or for other reasons, the residual owner may also own part of the policys cash value.
The equity owner (e.g., the insureds spouse or a trust for his or her benefit) retains a death benefit equal to the policys cash value not owned by the residual owner. The equity owner has access to the policys cash values and pays the costs associated with that portion of the policy. The equity owner may use the policys cash value to supplement retirement income or for other purposes.
