You’ve devoted a lifetime to creating your wealth and after years of hard work, it’s important that your assets be carefully preserved for your family. Perhaps you’ve prepared a will to oversee the disposition of your estate upon your death. While this is an important first step, you should also begin to consider how estate taxes might affect your financial situation, once it’s time for those assets to be passed on.
Despite what you may have heard, the estate tax is still alive and well. During the phase out period from 2002-2009, the top estate tax rate never drops below 45 percent. In 2010, the estate tax is scheduled to be repealed. However, in 2011, the tax is resurrected and – at 55 percent rate – returns as strong as ever. As you can see, it is still vital to develop a strong estate plan to deal with any issues you may come across.
As you build your estate plan, you might find a need for a life insurance policy. A life insurance policy can help ensure that cash will be available to pay estate taxes and other estate expenses such as probate and attorney fees. However, simply purchasing a life insurance policy may not solve the larger problem of estate taxes. If either you or your spouse owns a life insurance policy, it would be included in the value of your estate, most likely increasing the value. This would in turn increase the estate taxes due – which is not the solution you are looking for! This ballooning tax bill can be avoided by having someone other than you or your spouse own the policy.
One solution is to have the policy placed in an irrevocable life insurance trust, or ILIT. The primary purpose of this type of trust is to hold assets (such as a life insurance policy) outside of your estate for federal estate tax purposes. If the insurance policy is owned by you, then it will be subject to estate taxes. But if the policy is owned by the trust and not included in the value of your estate, you will be reducing estate taxes.
Suppose this life insurance policy was owned by the trust and designed to pay when the second spouse dies. Remember, because of the unlimited marital deduction – which allows spouses to leave any size estate to the surviving spouse completely free from federal estate taxes – estate taxes can be deferred until that time. When both spouses pass away, the insurance proceeds would then be distributed to the beneficiaries according to the terms you determined through the trust. Because these funds are legally owned by the trust, they are not included in either spouse’s estate and are available to your heirs, as you had intended.
In addition, depending on your circumstances, life insurance and an ILIT can provide many other benefits besides preserving the value of your estate for your heirs. Some benefits include: the insurance policy values grow tax deferred during the insured’s lifetime, proceeds from the policy can provide liquidity to buy out a deceased partner’s share of a business and the insurance proceeds can provide additional assets and enable you to treat all children equally when only certain children inherit a family business.
As always, you should consult your estate planning advisors before establishing an ILIT, as making such a decision is truly irrevocable. As you can see, a detailed estate plan is something you should not overlook. There are many options and strategies that can help you create a plan that works for you and your family. A meeting your financial consultant and estate planning advisors can get you on the right path. If you would like to receive the publication, Planning Your Estate: A Step-by-Step Guide to Help Create Financial Security for Yourself and Your Family, by A.G. Edwards & Sons, Inc., please contact financial consultant, Shelley Phillips-Mills at 800-947-5456.