Dear Michael: At the end of last year, I inquired with an insurance agent friend of mine about purchasing enough life insurance to pay any estate taxes. Because I lost my wife years ago and never remarried, my estate is in excess of the five million two hundred and fifty-thousand dollars. I was truly concerned about the possibility of the Unified Credit dropping to a lower amount.
After all was said and done, I still need the life insurance to pay the estate taxes. I applied for the insurance in December and the agent took a check with the application. Now I have been approved and am wondering if I did this in the right way because I acted in haste. He said we can now put the policy into a trust and it would be excluded from my estate. What's your opinion? – Haste Makes Waste?
Dear Haste: With an estate in excess of the Unified Credit, sometimes it makes sense to buy life insurance to cover the estate tax issues than other options. Many people use gifting to lower their estate taxes. But with values going so high so quickly, sometimes it's a lot cheaper to gift life insurance premiums to your children or to a trust than to gift real property.
For example, if you may need to move fifty, sixty or even one hundred thousand dollars of real property per year to remove the inflation from your estate and/or lower your estate below the taxable level, or you could gift ten or fifteen thousand dollars a year to provide for the estate taxes, which one is less expensive and gives you more control over your assets in the years to come? Most people use a combination of gifting real property and setting up Irrevocable Life Insurance Trusts (ILIT's) just to maintain with inflation.
However, IRS has a certain way they want things done when you purchase life insurance. The number one rule is ‘You or your spouse cannot buy the insurance'. When the agent took a check from you, he violated the ‘first' rule of buying life insurance for estate tax purposes.
When he said ‘We can move it to a trust after the policy is approved' this, too, was a mistake. IRS states any life insurance not originally purchased by the trust (or by your children) that is placed into trust will still be included in your estate for estate tax purposes for three years. If you die within the next three years, you will have increased your estate taxes rather than decreased them.
Many people want to see if they are insurable and at what cost before they go through the process of setting up a trust. For these people, an application can be submitted. Once you are approved and you approve of the pricing, then the trust can be established and the trustee can do a second app mimicking the first so that the trust applied for the insurance rather than you. Most insurance companies, if completed in a timely fashion, have no new requirements for approving the second policy.
Once the trust is established, you must gift to the trust as soon as possible – before the second policy is issued, by setting up a checking account for the trust. Likely the financial institution will need a copy of the trust to establish a checking account.
IRS has a second rule which states once the funds are in the trust, the trustee must inform all the beneficiaries of the trust, using a Crummey Letter, of this deposit and give them ample time to withdraw these funds. IRS typically states this period to be sixty days. If the trustee hears no response within 60 days, s/he can pay the premium.
However, this time frame can be shortened by the other beneficiaries writing back to the trustee they do not want the funds and then the trustee can pay the insurance premium when the new policy arrives. Being as the beneficiaries and the trustee(s) are typically family members (children), this can all be done by email, but the trustee must give some consideration time (one week) before paying the premium and s/he must keep the copies of the emails received by the siblings in a separate paper file for possible audit in the future.
When the premium comes due the next year, you have to pay it earlier than the due date. If you get the billing one day, make a deposit to the trust account, the trustee sends out an email and receives responses in the next day and pays the premium, this alacrity likely won't survive and IRS audit. IRS would argue the beneficiaries did not have sufficient time to consider withdrawal of the funds. So, get the gift of the premiums into the trust early, get the letters out to the beneficiaries, and pay the premium after a period of time – one to two weeks – and IRS will be fine with the process.
The agent who sold you on this has had no or little training in handling estate issues or how IRS views trusts and gifts. You need to find an agent who knows exactly what they are doing, because not following the proper steps could cost your family hundreds of thousands of dollars.