Estate Planning
Chapter 11:
Life Insurance in Estate Planning
© 2004 ME™ (Your Money Education Resource™)
2
Types of Life Insurance
(1 of 2)
 Term insurance
 Must die during term
 Funds temporary needs
 Cost as you get older
 Universal life
 Term policy with a cash accumulation
 Premium is flexible
 Funds temporary needs
© 2004 ME™ (Your Money Education Resource™)
3
Types of Life Insurance
(2 of 2)
 Variable universal life
 Universal life with the ability of the
owner to determine how to invest the
cash accumulation
 Whole life
 Permanent insurance
 Generally level premium
 Funds permanent need
© 2004 ME™ (Your Money Education Resource™)
4
Types of Annuities
(2 of 2)
 Fixed
 Payments don’t change
 Joint and survivor
 Term certain
 Rate guarantees: teaser rates
 Guaranteed Return (GRA): will always
receive investment even in surrender
 Market Value (MVA): if surrender and rates
have gone up, lose value just like a bond
 Funds are not in sub accounts
© 2004 ME™ (Your Money Education Resource™)
5
Types of Annuities

(2 of 2)
Variable
 Payments change based on investment performance
 Can make investment selections in sub accounts
 Guaranteed Retirement Income Benefit (GRIB):
 Income based on account value on account anniversary
 Guaranteed Lifetime Withdrawal Benefits (GLWB):
 Rider with a fee
 Even if market value of accounts fall, can maintain
withdrawals
© 2004 ME™ (Your Money Education Resource™)
6
Types of Annuities
(2 of 2)
 Immediate
 Payments begin now
 Deferred
 Payments begin in future
 Can invest unlimited amount
 Surrender charge generally in first seven years
 10% penalty if withdraw funds before 59 1/2
 Single premium or periodic payment of premiums
© 2004 ME™ (Your Money Education Resource™)
7
Types of Annuities
 Longevity Annuities (Deferred Income Annuity)
 Premiums limited to lesser of:
 $100,000
 25% of account balance
 Payments must begin by at least age 85
 Invest $50,000 at age 55


At age 65: $6168/year male
At age 85: $45733/year male
$5837/year female
$40362/year female
 Can be joint and survivor annuity
 Funds used to purchase contract not subject to RMD
© 2004 ME™ (Your Money Education Resource™)
8
Objective of Life Insurance
 Protect income stream for beneficiaries
 Stay at home soccer dad
 A source of funds for education
 Type of insurance for this?
 Provide liquidity at death
 Type of insurance for this?
 A source for retirement income
 Type of insurance for this?
 Create or sustain family wealth
 Type of insurance for this?
© 2004 ME™ (Your Money Education Resource™)
9
Parties to a Life Insurance
Policy
 Owner
 Person who has title to the policy
 Insured
 Person whose life is covered by the
policy
 Beneficiary
 Person entitled to receive the death
benefit once the insured dies
© 2004 ME™ (Your Money Education Resource™)
10
Income Tax Treatment of Life
Insurance (1 of 4)
 General
 No income tax
 Transfer for value exception
 Income tax on proceeds if transferred for value
 Except transfers to:
 The insured
 Partner of insured
 Partnership/corporation where insured is
partner/ shareholder or officer
 Gift of policy
© 2004 ME™ (Your Money Education Resource™)
11
Income Tax Treatment of Life
Insurance (2 of 4)
 Settlement or cash surrender
 Lump sum benefit
 Annuity
 Income taxation occurs to extent of interest
 Policy dividends
 Return of basis
 Loans
 No income tax consequences
© 2004 ME™ (Your Money Education Resource™)
12
Income Tax Treatment of Life
Insurance (3 of 4)
 Policy exchanges 1035
 Life insurance can be exchanged for another
insurance policy or an annuity tax free
 Also long-term care policy
 Also annuity for an annuity
 Premiums in initial year of policy???
 An annuity can not be exchanged for an
insurance policy tax free!!
© 2004 ME™ (Your Money Education Resource™)
13
Income Tax Treatment of Life
Insurance (4 of 4)
 Accelerated death benefits
 Viatical settlements are income tax free
 Need chronically ill or terminally ill
 Chronically Ill
 Certified by doctor as being unable to perform at
least two activities of daily living
 Terminally Ill
 Certified by a doctor to die from illness within
two years
 No income tax consequences even if miraculous
recovery
© 2004 ME™ (Your Money Education Resource™)
14
Gift Tax Treatment of Life
Insurance (1 of 3)
 Changing the beneficiary on the life
insurance policy
 No gift tax consequences
 You could always change it again
© 2004 ME™ (Your Money Education Resource™)
15
Gift Tax Treatment of Life
Insurance (2 of 3)
 Outright gift of a life insurance policy
 Premium pay status
 If premiums are being paid then the gift tax
value is the sum of the policy’s interpolated
terminal reserve plus unearned premiums
 Paid up policy
 If paid up where premiums are no longer
necessary then the gift tax value is the
replacement cost of the policy
© 2004 ME™ (Your Money Education Resource™)
16
Gift Tax Treatment of Life
Insurance (3 of 3)
 Gifts of premiums
 The gift is equal to the cash transferred
 If paid to a trust – need a Crummey
provision
 Gifts of life insurance to charities
 Income tax deduction equal to the fair
market value of the policy
 Why would you do this???
© 2004 ME™ (Your Money Education Resource™)
17
Federal Estate Tax Treatment
of Life Insurance
 I.R.C. Sec 2033 – Life insurance on someone else’s life
 The interpolated terminal reserve plus any unearned
premium will be included in the gross estate
 Life insurance on the insured/decedent’s life
 Generally he death benefit will be included in the
gross estate unless no incidents of ownership
 I.R.C. Sec. 2035 – The three year rule
 Policies transferred within three years will be included
in the gross estate
 Exception: does not apply to sale of policy
© 2004 ME™ (Your Money Education Resource™)
18
Creation of a Life Insurance
Trust (ILIT)
 Trust holds life insurance policy!
 Utilizing the annual exclusion
 Crummey provision
 Lapsed powers (5x5 rule)
 Continuing power to appoint
 Avoid requiring the trust to pay proceeds to
estate for taxes or administration expenses
because it causes inclusion in the gross estate
 Provide liquidity
 Allow trust to purchase assets of the estate
 Allow trust to loan money to the estate
© 2004 ME™ (Your Money Education Resource™)