A DOZEN USES OF LIFE INSURANCE IN
ESTATE PLANNING
This Material is Not Intended for Use
with the General Public
0201956
0201956-00002-00 Ed. 06/11 Exp. 06/13
IMPORTANT INFORMATION
This material has been prepared by The Prudential Insurance
Company of America to assist financial professionals in obtaining
continuing education credits. It is designed to provide general
information in regard to the subject matter covered. It should be used
with the understanding that it does not constitute legal, accounting or
tax advice. Such services should be provided by the client’s own
legal, accounting and tax advisors. Accordingly, information in this
document cannot be used for purposes of avoiding penalties under
the Internal Revenue Code.
Life insurance is issued by The Prudential Insurance Company of
America and its affiliates. All are Prudential Financial companies
located in Newark, NJ, and each is solely responsible for its own
financial condition and contractual obligations. Life insurance policies
contain exclusions, limitations, reductions of benefits and terms for
keeping them in force. A financial professional can provide a client
with costs and complete details. The availability of other products and
services varies by carrier and state.
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IMPORTANT INFORMATION
Life insurance policy cash values are accessed through withdrawals
and policy loans. Loans are at interest. Unpaid loans and
withdrawals cause a reduction in cash values and death benefits. In
general, loans are not taxable, but withdrawals are taxable to the
extent they exceed basis in the contract.
Loans outstanding at policy lapse or surrender, prior to the death of
the insured, will cause immediate taxation to the extent of the gain in
the contract. For policies that are Modified Endowment Contracts,
distributions (including loans) are taxable to the extent of income in
the contract, and an additional 10% federal income tax penalty may
apply. Clients may wish to consult their tax advisor for advice
regarding their particular situation.
Securities and Insurance Products:
Not Insured by FDIC or Any Federal Government Agency. May Lose Value.
Not a Deposit of or Guaranteed by Any Bank or Bank Affiliate.
Prudential, the Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities.
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BENEFITS OF LIFE INSURANCE
• Death benefit generally received income tax-free
under IRC §101(a)
• Death benefit can be structured to be estate taxfree
Although the primary reason to purchase life insurance is for the death
benefit, many policies provide the potential for cash accumulation
• Tax-deferred cash value build-up
• Generally can borrow cash value without tax
 Exception: modified endowment contracts
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BENEFITS OF LIFE INSURANCE
• Notwithstanding the time value of money,
periodic small gift transfers for premium can
provide large death benefits
• Form of property people generally don’t mind
giving away during lifetime
• Unique in its ability to provide instant substance
(death benefits) where insured is prevented from
doing so because of death (life insurance is selfcompleting)
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#1 INCOME REPLACEMENT
• Life insurance death benefits can create a fund
that survivors (beneficiaries) can access to help
replace income lost at the death of a wage
earner.
 Family with few assets dependent on the income
of an insured
 Survivors (beneficiaries) who may be asset rich
but income poor
 Inherited assets are low/non-income producing (i.e., land,
minority interest in a closely held business)
 Trust beneficiary with minimal income distributions (i.e.,
income-only trust beneficiaries)
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#2 SOURCE OF CASH
• Life insurance death benefits can
instantaneously create a pool of cash at an
insured’s death to help:
 Pay down or pay off mortgages or other debts
 Fund services provided by the deceased (house
cleaning, child care, cooking, etc.)
 Fund for education
 Fund for the care of individuals who are physically
or mentally not able to provide for themselves
(i.e., children with special needs)
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#3 SOURCE OF LIQUIDITY
• Life insurance death proceeds can be a source of
liquidity to help pay federal/state death taxes and
other death-generated costs (final expenses,
administrative costs).
 Typical plan for a married couple with large estate:
 An amount up to the applicable exclusion amount ($5M in
2011) passes to a bypass trust for benefit of family. This
amount totally avoids federal estate tax.
 Balance of property passes outright, or in a qualifying
marital trust, to a U.S. citizen spouse without estate tax.
At spouse’s death, any property in excess of the spouse’s
estate tax exemption amount is subject to estate tax.
 Result: Delays federal estate tax until death of the
surviving spouse.
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#3 SOURCE OF LIQUIDITY (CONTINUED)
• Examples of techniques used to help pay
death taxes:
 Second-to-die life insurance in an irrevocable life
insurance trust
 Standby survivorship trust for clients who want to
retain control over the policy (or avoid gifting)
during the lifetime of both spouses
 “B” trust funding for insurance on widows with
bypass credit shelter trust assets
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#4 NONCITIZEN SPOUSE MARITAL DEDUCTION
• Life insurance proceeds can help address the
marital deduction limitations of a surviving
noncitizen spouse.
 To qualify for the unlimited estate tax marital
deduction, property passing to a surviving
noncitizen spouse must pass into a qualified
domestic trust (QDOT).
 Distributions of principal from a QDOT during the life of
the noncitizen spouse, except for hardship, are subject to
estate tax.
 Assets remaining in QDOT at the death of noncitizen
spouse do not qualify for that spouse’s estate tax
exemption, rather they are subject to estate tax as if they
were included in the estate of the prior deceased spouse.
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#4 NONCITIZEN SPOUSE MARITAL DEDUCTION
(CONTINUED)
• Examples of methods to address marital
deduction limitations of a noncitizen spouse:
 Not willing to create a QDOT: Assets passing to a
noncitizen spouse and other heirs in excess of the
applicable exclusion amount ($5M in 2011) will be
subject to estate tax.
 Result: Tax triggered at death of first spouse. An
individual life insurance policy insuring the deceased
spouse can help pay estate tax.
 Noncitizen spouse can own insurance on other
spouse to provide source of funds free of the
restrictions imposed by the QDOT.
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#5 ENHANCE AN ESTATE
• Life insurance death benefits can help reduce
estate planning problems where there is a need
to instantaneously enhance the size of an
insured’s estate.
• Commitments for substantial transfers (like those
on the next page) in the future can be made with
more modest current transfers for life insurance
premiums.
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#5 ENHANCE AN ESTATE (CONTINUED)
• Examples of where life insurance’s unique ability
to provide instant substance can help address
estate problems when there is a commitment /
desire to transfer substantial wealth in the future:
 Provide wealth for children of prior marriage
 Limitation of the QTIP trust solution
 Spousal rights in qualified plan balances
 Divorce and child support commitments
 Help pay for the purchase of a business interest
 Help “equalize” estates of heirs who do not work in
the family business
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#6 STABILIZE A BUSINESS INTEREST
• Life insurance death proceeds can help
provide additional cash to help reassure
creditors, vendors, distributors and
employees that the business is financially
sound.
 Help satisfy business debt
 Provide cash flow during the inevitable crisis that
follows the death of a key person
 Create a “stay bonus” fund to retain key
employees during a transition period of a business
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#7 MITIGATE COMPLEX TRUST INCOME TAX
• A high cash value life insurance policy owned by
a bypass or other complex trust can help to
mitigate the impact of the compressed trust
income tax rates.
 The combination of tax-deferred cash
accumulation in the policy and the availability of
tax-free loans offers the opportunity to mitigate the
trust income tax rates during the life of the insured.
 Properly structured, trust beneficiaries receive the
insurance proceeds estate and income tax-free
(under IRC 101(a)). In contrast, trust assets not
subject to estate tax do not receive a step-up in
basis and will thus be subject to tax when sold.
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#8 ENHANCING ASSETS WITH LIFE INSURANCE
• Assets may be enhanced to provide a potentially
larger sum though the death benefit provided
from the purchase of life insurance.
 Purchase of insurance on the surviving spouse’s
life in the bypass trust (“B” trust) of the deceased
spouse is a way of potentially leveraging the
exemption amount of the deceased spouse.
 Insurance can potentially leverage the generation
skipping transfer (GST), annual exclusion and gift
tax applicable exclusion amounts of the donor.
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#8 LEVERAGE ASSETS (CONTINUED)
 Trusts having a generation-skipping ratio greater
than “0” (thus subject to GST tax) can purchase
insurance on the non-skip beneficiary to help pay
the GST tax that will be payable when that person
dies.
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#9 SUPPORT STRETCH OF IRAS &
QUALIFIED PLAN DISTRIBUTIONS
• Life insurance can help qualified plan participants
and IRA owners maximize their ability to stretch
distribution of qualified retirement funds over multiple
generations.
• Basic “Stretch” concept:
 Delays distributions for as long as permitted
 Names a young beneficiary to minimize distributions
 Distributes only the minimum amount required
 Result: Compounded tax-deferred earnings
potentially creates substantial wealth for future
generations
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#9 SUPPORT STRETCH OF IRAS &
QUALIFIED PLAN DISTRIBUTIONS
• Example: Jack and Jill
 During Jack’s Life:
• Jack, IRA participant and his wife, Jill, is
named as beneficiary of his IRA.
• Jack first distribution is due by 12/31 of the
year he reaches age 70½.
• Jack can choose to defer his first distribution
to April 1 of the year following the year he
turned age 70 1/2, but he would still be
required to take another distribution by 12/31
of the same year.
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#9 SUPPORT STRETCH OF IRAS &
QUALIFIED PLAN DISTRIBUTIONS
• Example: Jack and Jill (continued)
 After Jack’s Death During Jill’s Life:
• Jill elects to treat the IRA as her own, does not
begin distributions until the year she reaches
age 70½.
• Jill is now the owner of the IRA, names
grandson John, as beneficiary.
• Jill receives distributions until death (including
the year of death).
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#9 SUPPORT STRETCH OF IRAS &
QUALIFIED PLAN DISTRIBUTIONS
 After Jill’s Death:
• John, elects to take distributions over his
lifetime extending income tax deferral over his
life expectancy of many years. Estate taxes are
paid from other funds.
• A survivorship life insurance policy insuring Jack and
Jill can help provide John the liquidity needed to pay
estate taxes.
 Jack's unneeded RMDs could be used to help pay
premiums.
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#10 REPLACE ASSETS LOST TO TAX
ON IRD ASSETS
• The death proceeds on an individual life insurance
policy can be a source of cash to help replace assets
lost to income tax on “income in respect of decedent”
(IRD) assets.
• IRD assets are subject to income tax even if the
estate is not subject to estate tax.
• Example of IRD assets: annuities, traditional IRAs,
qualified retirement plans (i.e.,401(k), SEPs, 412(i)
etc.).
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#10 REPLACE ASSETS LOST TO TAX
ON IRD ASSETS
• To calculate income tax on IRD
 Calculate the estate tax on the total taxable estate
including qualified plans and IRAs.
 Calculate the estate tax without the qualified plans
and IRAs.
 Deduct this difference from the qualified plan/IRA
balance.
 Calculate the income tax on the remainder.
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#10 REPLACE ASSETS LOST TO TAX
ON IRD ASSETS
• Roth conversion opportunity
 IRA owner names spouse as beneficiary. At IRA
owner’s death, spouse converts IRA to Roth IRA in
spouse’s own name. Spouse names children or
grandchildren as beneficiaries.
 No minimum distributions are required during
lifetime of surviving spouse allowing for tax-free
compounding of Roth assets.
 Entire IRA amount can be passed on to younger
beneficiaries income tax-free if all requirements are
met
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#10 REPLACE ASSETS LOST TO TAX
ON IRD ASSETS (CONTINUED)
• Roth conversion opportunity
 Requires cash (preferably from sources outside of
the traditional IRA) to pay taxes due at time of
conversion.
 To help pay the tax due at conversion, purchase life
insurance on the life of the traditional IRA owner
with spouse as the beneficiary.
 Depending on estate value and growth of Roth,
there may be a need for life insurance on spouse’s
life to pay estate taxes.
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#10 REPLACE ASSETS LOST TO
TAX ON IRD ASSETS
• Example: Jack and Jill Roth Conversion
 After Jack’s Death During Jill’s Life:
• Jill receives IRA at Jack’s death
• Jill converts to a Roth IRA, pays income tax from other
funds in year of conversion.
• Jill makes Roth IRA beneficiary payable to a trust for the
benefit of John.
• No RMDs required during Jill’s lifetime.
 After Jill’s Death:
• Distributions to John after Jill's death are tax-free if account
is 5 years old or older. Estate taxes are paid from other
funds.
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#10 REPLACE ASSETS LOST TO TAX
ON IRD ASSETS
• Life insurance on Jack's life can help provide Jill
the liquidity needed to pay the income tax on the
conversion of the IRA to a Roth.
 Jack's unneeded RMDs could be used to help pay
premiums
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SUMMARY: USE OF LIFE INSURANCE IN
ESTATES WITH QUALIFIED ASSETS
• The key to maximizing the sum left to the beneficiary
of an estate with qualified retirement assets is to
make sure the beneficiary does not lose benefits to
taxes.
• For all estates with qualified retirement assets, it
means having funds to offset the loss caused by
income tax on IRD.
• For an estate subject to estate tax, it means there
must also be adequate funds to provide estate tax
liquidity without using qualified retirement assets to
pay estate taxes.
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#11 ESTATE FREEZE
• Life insurance proceeds can provide funds to
purchase “hot” assets (high appreciation assets),
removing them from survivor’s estate.
 Death proceeds from an individual life insurance
policy owned by an insurance trust is used to
purchase “hot” assets received by the surviving
spouse as part of the marital deduction bequest.
 Result: Because of step-up in basis, no income tax
is due if purchase is made at fair market value.
“Hot” assets are moved outside of the estate.
Surviving spouse receives insurance proceeds with
less growth potential.
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#12 CHARITABLE WEALTH REPLACEMENT
• Life insurance can help to fulfill a desire to make
a substantial gift to charity.
 Many people don’t make gifts/bequests to charity
because they fear their family will be deprived of
an adequate estate or family members will be
unhappy about being deprived of the assets left to
charity. Life insurance can help alleviate these
concerns
 Charitable Remainder Trust: Insurance purchased to
replace some or all the asset passing to charity
 Testamentary Charitable Lead Trust: Insurance provides
source of income to family while trust income diverted to
charity
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