Alternatives to funding life insurance premiums.

• Author: Markoff, Michael

Clients facing the estate tax are often confused by advanced approaches to estate planning. Gifting techniques can be daunting and intimidating, even to the most sophisticated taxpayers. For many, life insurance continues to be the easiest and cleanest way to pay estate tax without risking premature death and IRS scrutiny. In essence, this allows prepayment of the estate tax from current assets, for the cost of a life insurance premium. Unless clients self-insure by continuing to pay premiums beyond their life expectancy in an aggregate amount equal to the death benefit, their heirs will receive a windfall (especially if the insured dies prematurely).

Whether clients purchase single-life or survivorship life insurance policies, to the extent that an irrevocable mast is the policy owner and beneficiary, the proceeds will pass estate tax free to their trust beneficiaries. The beneficiaries will then loan the proceeds to the executor, who will use it to pay the estate tax.

Problem

The most common obstacle encountered when coordinating life insurance in an estate plan is determining whether the premium payments fit within the Crummey powers in the irrevocable mist. Ordinarily, life insurance premiums paid to such a trust are deemed gifts, because the proceeds Hill ultimately benefit the trust beneficiaries after the insured dies. This type of gift will exhaust a portion of the donor's $1 million lifetime gift tax exemption. The more preferable option is to qualify the premiums for the annual gift tax exclusion, currently $11,000 per year per donee ($22,000 if the spouse consents to the gift). To do so, this gift must be of a present interest, which means that it must be enjoyed immediately. This is accomplished by giving each trust beneficiary a Crummey power or withdrawal power. The problem is, even when using "hanging" powers, because permanent life insurance products (such as whole-life and variable life) are frequently purchased to satisfy the estate tax problem, the premiums often exceed the $11,000 (or $22,000) per-beneficiary Crummey withdrawal powers.

Solution

One possible solution is to have the irrevocable trust own an asset that produces sufficient income to pay the life insurance premiums without requiring additional contributions.

Example: H and W are married; they have two adult children and no grandchildren. H Owns 100% of O, a manufacturing company. He also owns, in his sole name, the building in which O is located. H is...