Specialized trusts & private loans can help address some “what ifs”.
Estate planning professionals have to deal with ambiguities today. Constant tax law revisions aside, there are contingencies of family life that may require added flexibility in estate planning. Fortunately, there are tools that can help to arrange it.
Standby trusts. As the name implies, these trusts go into effect when and if families happen to need them. A common scenario: a family has a history of Alzheimer’s or other hereditary illnesses, and mom or dad worry about one day being mentally or physically disabled to the point where they can’t make financial decisions. In response, they work with estate planning professionals to create what is presently an unfunded revocable trust – a standby trust.
A standby trust goes into effect upon a triggering event. This is often a doctor’s diagnosis. If a doctor diagnoses a trustor with Alzheimer’s, for example, the revocable standby trust can then become an irrevocable trust. Title to the trustor’s property is transferred into the trust via a durable power of attorney, and the standby trust converts to a grantor trust.1
Sometimes the triggering event is a prolonged disability or illness – and if the trustor recovers from it, the standby trust can remain revocable and the trustor can regain control over the assets.1
From a life insurance standpoint, the mechanics work as follows. One spouse buys either a survivorship life insurance policy or a single life policy insuring the other spouse, naming the standby trust as the policy’s contingent owner. The policy owner has control plus access to the policy’s cash value. If the policy owner dies first, the policy is transferred to the trust and the trustee names the trust as the policy beneficiary. Only the policy’s fair market value is added to the decedent’s estate; the trust pays the policy premiums until the surviving spouse dies, at which point the trust receives the policy death benefit tax-free.2
Spousal lifetime access trusts. At the end of 2010, Congress increased the lifetime gift tax exclusion to $5 million for 2011 and $5.12 million for 2012 – and it also made the lifetime gift tax exclusion portable between married spouses.3
This opened up a remarkable short-term window of opportunity. Before 2013 arrives, wealthy couples can potentially shift up to $10 million in assets out of their estates tax-free. That limit rose to $10.24 million in 2012 (it was adjusted for inflation).3
This temporary increase in the lifetime gift tax exclusion gives couples a chance to reduce the size of a taxable estate through gifting or an irrevocable trust without a retained interest. However, some couples would rather retain the gifted funds, especially if seems that one spouse might live decades longer than the other.
If that is the concern, a spousal lifetime access trust may provide a solution. One spouse creates this irrevocable trust for the benefit of the other. One spouse is named the grantor; the spouse expected to outlive him/her is named the trustee.
Often, the SLAT is funded with a life insurance policy; premiums are paid using cash gifts from the grantor. (A SLAT is best funded with separate property of the grantor spouse rather than community property, as you don’t want the assets within the trust included in the estate of the surviving spouse.)4
Basically, this is an irrevocable life insurance trust (ILIT) with one key difference: the spouse is a beneficiary as well as the children/grandchildren. The surviving spouse (trustee) may distribute assets out of the trust for his/her own benefit as well as the benefit of the heirs. When the surviving spouse passes away, the trust terminates and the heirs receive a tax-free life insurance benefit.4
What if the trustee dies before the grantor dies? If that happens, the trust assets are usually inaccessible to the grantor. How do you prepare for that? One option is to buy a life insurance policy on the life of the trustee.4
Private demand loans. These are also arranged with the help of either a survivorship life insurance policy or a single life policy. In this instance, an ILIT is created but the grantor loans funds to the ILIT instead of gifting funds. The trustee uses these loaned funds to pay premiums on a single life or survivorship policy. (The annual gift to the ILIT may vary depending on required interest rates stipulated by the IRS.) The loan is payable on demand if the grantor needs the money; the trustee can do so using the cash value of the policy. So the couple retains indirect control over the policy while they live (with access to its cash value) while also establishing an irrevocable trust.2
Could these ideas work for you? They may be worth exploring. These flexible estate planning techniques all use life insurance creatively, offering couples access to cash value while aiming to keep a policy’s death benefit out of a spouse’s taxable estate.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.