When an individual dies, every piece of property owned by that deceased individual must be transferred to a new owner.  Both real property and personal property (tangible and intangible) can pass to the decedent’s heirs in a number of ways.  Property can take on many forms, such as shares of a closely held business (i.e. corporation, limited liability company, partnership), real estate, bank accounts, stocks, bonds, mutual funds, life insurance, annuities, qualified retirement plans (401(k), profit sharing, SEP, defined benefit), IRAs, Roth IRAs, 403(b) plans, 457(b) plans, non-qualified deferred compensation plans, notes and loans receivable, stock options, collectibles, jewelry, cash, etc.

Being able to discuss the post-death transfer of all types of property with your clients can give you an edge as a trusted professional advisor.  Many clients are under the mistaken impression that all their property will pass under the terms of their wills.  Nothing could be further from the truth.  Each and every piece of property owned by a client at death must be inventoried, valued, and distributed according to the property transfer laws of descent and distribution.

Nine Ways Property Can be Legally Transferred at Death

• Intestate … property owned in a sole name (individually) is considered probate property and will pass according to statutory state intestacy law when there is no will. The final distribution must be approved by the Probate Court
• Will … property owned in a sole name (individually) is considered probate property and will pass to heirs according to specific directions in a legally executed will. The final distribution must be approved by the Probate Court
• Living Trust … the trust may be revocable or irrevocable. A revocable living trust automatically becomes irrevocable upon the death of the grantor. Property owned in the legal name of the trustee passes to trust beneficiaries according to the terms of the trust.  The remainder beneficiaries of the trust may be individuals or another trust.  Property owned by a living trust will NOT be subject to probate.
• Testamentary Trust … property owned in a sole name (individually) first passes through the will, and then into the trust by specific language in the will. The remainder beneficiaries of the trust may be individuals or another trust.  The property passing through the will is probate property and the final distribution to the testamentary trust must be approved by the Probate Court.
• Contract in Lifetime … a classic example of a contract in lifetime is a buy sell business transfer agreement. At the death of a business owner, the shares of the business are purchased from the estate by a third party (i.e. corporation or surviving shareholder).  This transaction will NOT be subject to probate.Another good example is a contingent owner designation of a third party owned life insurance policy.  Upon the death of the policy owner while the insured is still alive, the ownership of the policy will automatically transfer to the contingent owner and will NOT be subject to probate.

• Beneficiary Designations … life insurance, annuities, qualified retirement plans, IRAs, non-qualified deferred compensation benefits, and transfer on death (TOD) designations of non-qualified investment accounts all pass to the designated beneficiary and will NOT be subject to probate. The designated beneficiary may be an individual or a trust.
• Joint Tenancy with Right of Survivorship (JTWROS) … this undivided interest in property passes automatically by operation of law to the surviving joint owner and will NOT be subject to probate
• Tenancy in Common … this undivided interest in property owned in a sole name (individually) with other tenant in common owners passes according to specific directions in the will of the deceased or by the intestacy laws of the state if there is no will. The tenant in common interest is probate property and final distribution must be approved by the Probate Court.
• Qualified Disclaimer … if the recipient of any type of property executes a qualified disclaimer within nine months of the death of the owner of probate property, the property in question will instead pass to the remaining beneficiaries of a probate estate. For life insurance, annuities, qualified retirement plans, and IRAs, the property in question will pass to the contingent beneficiary when the designated primary beneficiary disclaims.  Sometimes a “double disclaimer” needs to take place in order for the disclaimed property to be transferred to the desired heir.

Each and every asset owned by a deceased individual must pass through one of the property transfer methods described above.  Financial professionals should record and update an accurate asset inventory for their clients which lists current value, asset title, and whether the asset will pass through the probate court process or not.  To help you gather detailed client information for wealth distribution purposes, BSMG has created an Estate Planning Factfinder for your use.  This will help you organize financial information so you can provide more accurate recommendations to your clients.  This Estate Planning Factfinder and all other BSMG Factfinders can be accessed on the BSMG Website at www.bsmg.net.

State Estate Taxes and IRD Income Taxes

Also, certain states have state estate taxes that must be paid.  Generally, states that de-coupled from the federal estate tax system so they could continue to levy death taxes on their deceased residents have progressive state death taxes ranging from about 5% up to 16% depending on the size of the taxable estate.  There is currently a federal estate tax deduction for any state death taxes actually paid.  Examples of de-coupled states which levy state death taxes include Rhode Island, Massachusetts, Connecticut, New York, Maine, and Vermont.

States that remained coupled to the federal estate tax system currently have no state death taxes at all.  Examples of zero-tax coupled states include New Hampshire, Virginia, Florida, Texas, and California.  Financial professionals should advise their clients whether or not state death taxes may be part of their planning picture depending on whether their state is a de-coupled state or a coupled state.

Finally, financial professionals should advise their clients whether or not there will be any post-death income taxes on certain financial assets.  This post-death income is known as “income in respect of decedent” (IRD).  Two major types of financial assets affected by this post-death IRD tax are qualified retirement plans (i.e. IRA and 401(k)) and the deferred gain amount in excess of cost basis for non-qualified deferred annuities.

Plan beneficiaries of these assets will report the receipt of these post-death taxable amounts as ordinary income on their own federal and state personal income tax returns.  There are certain options available under the Internal Revenue Code and Regulations to spread out the IRD post-death taxation over a number of years after the account owner’s death if desired.  Generally, these rules allow up to 5 years as a post-death distribution option or, conversely, a post-death distribution option over the life expectancy of the beneficiary.  Smaller accounts may opt for the 5 year plan whereas larger accounts may find the life expectancy method more suitable to their needs.  Clients should consult their financial professionals and tax advisors to explore these post-death inherited IRA or inherited non-qualified annuity distribution options.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
russ@bsmg.net

The post How Different Types of Property are Legally Transferred at Death appeared first on BSMG.

Often times we find ourselves dealing with clients who have accumulated significant non-qualified annuity account values. Tax deferred Section 1035 exchanges, over many years, may have caused business owners, professionals or wealthy individuals to have large six figure or even seven figure account balances. In these accounts, the original cost basis continues to carry over through a series of Section 1035 exchanges.

Non-qualified annuities have become valuable financial assets that can be managed and preserved over a long period of time.  The annuities may be fixed, indexed, or variable contracts.  This preservation and management can be accomplished for spouses and non-spouses even long after the owner of a non-qualified annuity has died if certain distribution rules are followed.

In most cases, non-qualified annuities can remain tax deferred all the way until the death of the owner. Income taxes on the gain amount in excess of cost basis will eventually need to be paid by the beneficiary of the annuity after the annuity owner has died. This is known as income in respect of decedent (IRD). If planned well, this taxable IRD gain amount can be spread over many years after the death of the annuity owner in the form of an inherited non-qualified annuity.

Here is a detailed summary of the inherited distribution options available to spouses, non-spouses and trusts for inherited non-qualified annuities under IRC Section 72(s):

Spouse Designated Beneficiary

1. 5 year rule. Account value must be totally distributed within 5 years of death (IRC Section 72(s)(1))
2. Life expectancy rule: Annuitized life expectancy distributions must start no later than 1 year after the death of the holder-owner (IRC Section 72(s)(2)).
3. Spouse can continue the existing contract as his/her own and name a new beneficiary. The surviving spouse can continue tax deferral of gain in excess of cost basis all the way until death if desired (IRC Section 72(s)(3)).

Non-Spouse Designated Beneficiary

1. 5 year rule. Account value must be totally distributed within 5 years of death (IRC Section 72(s)(1)).
2. Life expectancy rule: Annuitized life expectancy distributions must start no later than 1 year after the death of the holder-owner (IRC Section 72(s)(2)).
3. PLR 200313016 also allows a life expectancy payout for inherited non-qualified annuities based on the Single Life Table of Treas. Reg. 1.401(a)(9)-9. This required annual inherited distribution must start no later than 1 year after the death of the holder-owner. Presumably, this would allow a deferred annuity type of product with an irrevocable income rider withdrawal option to be utilized. IRS ruled in PLR 200313016 that this method would satisfy the life expectancy requirement of IRC Section 72(s)(2).

Trust or Estate as Beneficiary

1. 5 year rule. Account value must be totally distributed within 5 years of death (IRC Section 72(s)(1)).
2. Life expectancy rule. It is not clear if the Life Expectancy rule can be used where a trust or estate is the beneficiary of a non-qualified annuity. No Treasury Regulations or IRS rulings exist for non-qualified annuities where a trust or estate is the beneficiary. A trust or estate is not considered to be an individual designated beneficiary under IRC Section 72(s)(4)). Legally, a trust or estate may be named as beneficiary, but it is not clear whether the life expectancy rule can be used.

Technical Tax Rules for Inherited Non-Qualified Annuities

There are certain technical rules that apply to the post-death distribution methods described above.  Here is a short list of the most important rules for inherited non-qualified annuities:

Technical Notes

1. Generally, the death of the holder (owner) of a non-qualified annuity terminates the contract and required distributions from the contract must commence under the rules of IRC Section 72(s). One of the distribution options described above may be chosen with the existing annuity carrier. An exception is the option for a spouse beneficiary to continue the contract as his/her own under IRC Section 72(s)(3). The new spousal continuation contract is still eligible for a tax free Section 1035 exchange to a non-qualified annuity with another carrier.
2. For income tax purposes, the distribution option chosen will be governed by either the LIFO distribution rules of IRC Section 72(e) or the exclusion ratio rules of IRC Section 72(b).
3. Where an Irrevocable Trust is the owner of a non-qualified annuity, IRC Section 72(s)(6) states that the holder for purposes of post-death distributions of a non-qualified annuity shall be the primary annuitant. With an Irrevocable Trust as owner, it’s important to determine who will be the annuitant, either the older parent (grantor of the trust) or the younger adult child (beneficiary of the trust).
4. There is currently no authority in the Code, Treasury Regulations, or Revenue Rulings for post-death transfers of non-qualified annuity funds from one annuity carrier to another annuity carrier after the holder-owner has died. However, in PLR 201330016, IRS permitted a post-death exchange of non-qualified annuity funds as long as the transfer was made directly from the old annuity carrier to the new annuity carrier. The IRS characterized this transaction as a permitted tax-free exchange of annuity contracts within the scope of IRC Section 1035(a)(3). Each annuity carrier involved in the exchange transaction must be consulted to determine their own business practices for this post-death situation.

BSMG can provide access to multiple annuity carriers to fund non-qualified annuities both during lifetime and as an inherited non-qualified annuity for legacy purposes.  Contact your BSMG Annuity Advisor to design a legacy annuity distribution plan for your best annuity clients.

Russell E. Towers JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net        

The post Distribution Options for Inherited Non-Qualified Annuities appeared first on BSMG.

For many years, irrevocable trusts have been structured for as grantor trusts, for income tax purposes, while still maintaining tax free status for estate tax purposes. A number of favorable IRS Revenue Rulings have solidified the irrevocable grantor trust power of substitution concept under IRC Section 675(4)(C).

This concept allows a grantor to substitute assets of equal value for those already in the trust, without causing any of the asset value to be included in their gross estate for estate tax purposes.

Grantor Trust – Here’s a short history of the important IRS Rulings which permit grantor trusts and the power of substitution concept:

• Rul. 85-13 was the first ruling which stated that a grantor of an irrevocable trust would be treated as owner of the trust assets only for income tax purposes but NOT for estate tax purposes.
• In Rul. 2004-64, IRS ruled that a grantor’s payment of income taxes on investment income of assets held in an irrevocable trust was NOT a taxable gift to the trust.
• In Rul. 2007-13, IRS ruled that a transfer of a life insurance policy from one irrevocable grantor trust to another irrevocable grantor trust would NOT violate the transfer for value rule. The death proceeds retained their income tax free character under IRC Section 101.
• Rul. 2008-22 was the first ruling to outline how a grantor trust with a Section 675(4)(C) power of substitution clause could be used so that a grantor could substitute assets of equal value for assets already held by the grantor’s irrevocable trust. The ruling stated that the trust assets would NOT be included in the grantor’s gross estate as a retained life interest under IRC Section 2036 and NOT be included as a power to alter, amend or revoke under IRC Section 2038.
• Finally, Rul. 2011-28 ruled that the Section 675(4)(C) power of substitution would NOT cause life insurance owned by an grantor irrevocable life insurance trust to be included in the gross estate as an incident of ownership under IRC Section 2042.
  

Picture a wealthy client with the following estate profile:

• A gross estate well in excess of the estate tax exemption ($5.49 million single and $10.98 million married) so that the excess is subject to a 40% estate tax rate plus state death taxes in many states.
• Over the years, the estate owner has made significant gifts of capital assets in a gain position to a grantor irrevocable trust to remove future appreciation from the gross estate. The grantor irrevocable trust contained a Section 675(4)(C) power of substitution clause. These were lifetime gift tax exemption gifts (currently $5.49 million single and $10.98 married). Form 709 U.S. Gift Tax returns were filed to document the gifts and their value.
• These gifted capital assets were real estate, publicly traded securities and shares in privately owned S Corps or LLCs. Under IRC Section 1015, the adjusted cost basis of these lifetime gifts carries-over and remains the cost basis for any future sale of those capital assets by the trust. This contrasts with capital assets included in the gross estate at death which would get a stepped-up basis to date of death value.
• The estate owner kept a part of his investment portfolios liquid in the form of significant money market account or bank holdings in an uncertain economic environment.

Given this estate profile, are there any recommendations that could be made to improve the estate plan using the Section 675(4)(C) power of substitution clause of the grantor’s irrevocable trust?

The grantor and his/her trustee could consider transferring money market cash to the trust as a substitute for a portion of the capital assets. This cash would have to equal the appraised fair market value of the capital assets now held by the trust. The capital assets would be returned to the grantor estate owner and would ultimately be included in the gross estate at stepped-up basis value for capital gains purposes for the heirs of the estate owner.

The substituted cash could be used by the trustee to buy a single pay or annual pay no-lapse guaranteed UL or SUL policy owned by the trust. The leveraged death benefit of this policy would be income tax free, estate tax free and provide an excellent guaranteed Internal Rate of Return (IRR) at life expectancy.

Let’s take a look at an example of how this may be beneficial to a wealthy estate owner who has a similar estate asset profile as that described above.

Facts of Hypothetical Estate:

Estate owner and spouse are each 67 years old and have a gross estate in excess of $50 million. They made lifetime exemption gifts of capital assets to a grantor irrevocable trust over the years totaling $5,000,000 with a cost basis of only $500,000.

This $500,000 cost basis carried-over to the trust for purposes of any future sale. Form 709 U.S. Gift Tax returns were filed.

The estate owner sold other personally owned real estate and the net after tax cash received on the sale was $6,000,000 which was deposited into a money market account.

Their grantor irrevocable trust holding the gifted capital assets has a clause which permits asset substitution under IRC Section 675(4)(C).

Hypothetical Recommendation to Take Advantage of Power of Substitution Clause:

1. Grantor transfers $5,000,000 of cash from the money market account into the trust. The cost basis of this cash is $5,000,000.
2. The trustee transfers $5,000,000 of capital assets that were originally gifted to the trust back to the grantor to complete the substitution transaction under Section 675(4)(C).
3. If the grantor holds these capital assets until death, there will be a stepped-up basis to date of the death value. In a 25% combined federal and state capital gains bracket, this will potentially avoid at least $1,125,000 of capital gains taxes for the heirs of the grantor when compared to the original carry over basis of the lifetime exemption gifts ($5,000,000 minus $500,000 cost basis = $4,500,000 potential capital gain x 25% capital gains tax = $ 1,125,000).
4. The trustee uses the $5,000,000 of substituted cash to purchase a single pay no-lapse SUL policy with a face amount of $15,776,000 (male 67-preferred / female 67-preferred) from a competitive carrier. The policy is a MEC, but death benefits of MECs are still income tax free. The death benefit is also estate tax free based on the rationale of Rev. Rul. 2011-28 which held that a Section 675(4)(C) power of substitution will NOT be considered to be an incident of ownership under IRC Section 2042.
5. The guaranteed IRR on the SUL policy at joint life expectancy (23 years) is 5.12%. In a 30% tax bracket, the pre-tax equivalent is 7.31%. This is truly outstanding in this continuing low interest environment for fixed financial assets and a significant improvement over the close to 0% current yield on money market accounts.
6. As an alternative, the $5,000,000 of substituted cash could be invested by the ILIT trustee in a portfolio of investments. Some of the interest, dividends or capital gains could be used to pay an annual no-lapse premium for an SUL policy instead. Since the trust is a grantor trust for income tax purposes, the grantor will report any income on his personal Form 1040 U.S. income tax return during lifetime. This payment of income taxes on trust income will indirectly reduce the grantor’s estate for estate tax purposes. So, the full gain on the trust investments will be retained by the trust and could be used to pay the annual SUL premiums.

For instance, a $200,000 annual premium (4% ROR on $5,000,000 trust principal) would purchase $13,188,000 of SUL no-lapse protection on the same Male 67 (Preferred) / Female 67 (Preferred) as was illustrated in the single pay scenario above. The IRR at joint life expectancy (23 years) is 8.02%. In a 30% tax bracket, the pre-tax equivalent is 11.46%.

In summary, the estate owner in the example above has avoided significant capital gains taxes for the heirs by using the substitution technique allowed for grantor trusts under IRC Section 675(4)(C). And the grantor trust has used the substituted cash to purchase a tax free guaranteed SUL for the benefit of the heirs with a great IRR at life expectancy.

Call BSMG at 800-343-7772 today to discuss a case or feel free to reach out to Russ Towers, Vice President Business & Estate Planning directly.

Russell E. Towers, JD, CLU, ChFC
Vice President, Business & Estate Planning
russ@bsmg.net

The post Leverage Your Clients Tax Benefits by Using Grantor Trust Power of Substitution appeared first on BSMG.

The ILIT or Irrevocable Life Insurance Trust has played a major role in estate planning for many years as the best financial method to provide a fund of money that’s highly leveraged, income tax free, estate tax free, gift tax free and generation-skipping transfer tax free.

However, over a period of time, the facts and circumstances of a client’s estate plan will change. The ILIT that served their needs fifteen or twenty years ago may not match their current estate planning desires.  The client may wish to add or delete trust beneficiaries, change the trustee or change certain key terms of the trust. These changes cannot be made because an irrevocable trust means exactly that … it’s IRREVOCABLE! The trust cannot be altered, amended, or revoked without adverse estate tax consequences. Possessing any of these rights or any incidents of ownership in the policy will cause the death proceeds to be included in the gross estate for estate tax purposes.

We often get the question, are there any options for transferring a policy out of an ILIT when the terms of the trust no longer meet the client’s planning objectives?

Let’s take a look at 5 planning options that may be able to rescue an old policy owned by an ILIT and still utilize it for current planning purposes.

1. The grantor can simply stop making annual gifts to the existing trust to pay premiums. The trustee could take a reduced paid-up policy or the policy could be surrendered completely if the income tax consequences are minimal. Future premium gifts can be made to a new ILIT which meets the client’s current planning objectives.
2. The ILIT can sell the policy to the insured grantor for its fair market value (generally the cash value). Then, the grantor can gift the policy ownership to a new ILIT for its gift tax value (generally the cash value). Since the policy ownership is initially transferred to the insured, this is one of the exceptions to the so-called transfer for value rule of IRC Section 101, and the policy death proceeds remain income tax free.  However, the insured must survive three years beyond the gift of the policy to the new ILIT to remove the death proceeds from the gross estate for estate tax purposes.
3. If the trust terms permit discretionary distributions of trust principal to trust beneficiaries, the policy can be transferred from the trust to the trust beneficiaries (i.e. children of the grantor). The children would become equal owners and equal beneficiaries of the policy.  Next, the children could voluntarily transfer policy ownership to the new ILIT where they are beneficiaries.  The transfer is estate tax free (insured estate owner never acquires ownership of the policy) and income tax free (a distribution of trust principal is tax free to the trust beneficiaries).
4. The existing ILIT can sell the policy to the new ILIT for its fair market value (cash value). Since the policy is never owned by the insured, there is no problem with the three year inclusion rule and the death proceeds remain estate tax free. However, the transfer of ownership to the new ILIT must still meet one of the exceptions to the transfer for value rule to keep the death proceeds income tax free. This result can be accomplished by drafting the new ILIT as a grantor trust for income tax purposes under the guidelines of Rev. Rul. 2007-13. In this case, the policy transfer is considered to be a transfer to the insured for purposes of the transfer for value rule under IRC Section 101. Or, the new ILIT can be a partner, in a partnership where the insured is also a partner.  This result is often accomplished by creating a Family Limited Partnership (FLP) and then transferring limited partner shares to the new ILIT.  Thus, the new ILIT is now a partner of the insured which meets another exception to the transfer for value rule under IRC Section 101.
5. Under certain limited circumstances, a legal merger of the old trust into the new trust can be accomplished if the beneficiaries of both trusts are the same and the beneficiaries lose no vested property rights in such a transfer. A special legal document plus written waivers by the trust beneficiaries is required to effectively create such a merger of trusts.

Contact BSMG Advanced Sales for a discussion of potential rescue techniques that may be considered based on your client’s estate planning objectives.

Russell E. Towers, JD, CLU, ChFC
Vice President, Business & Estate Planning
russ@bsmg.net

The post 5 Rescue Techniques to Remove a Life Policy from an ILIT appeared first on BSMG.

As people age into their 80s with longer life expectancies, their mental capacity is often diminished when it comes to managing their financial affairs. This declining capacity suggests an interesting issue which can impact whether continued gifting of premiums to Irrevocable Life Insurance Trusts (ILITs) can take place.

Many ILITs have been funded with no-lapse Universal Life (UL) and no-lapse Survivorship Universal Life (SUL) since the late 1990s. In a typical design, the account cash value falls to $0 by the time insureds reach their 80s. If the insured estate owner develops a reduced mental capacity such as Alzheimer’s, they may be unable to manage their financial affairs. It would be easy to miss premium payments into a no-lapse UL or SUL type of product which may cause the policy to quickly lapse for non-payment.

How can your client take the necessary steps to make sure this unfortunate scenario does not take place?

A Durable Power of Attorney document is a critical piece of a good estate plan for wealthy clients who have ILITs they are depending upon to offset federal estate taxes, state death taxes, and other final expenses. This legal document allows the power holder (attorney in fact) to execute specific legal and financial transactions on behalf of the incapacitated person. It may be crucial to a wealthy individual’s estate plan that a planned giving program be continued all the way until the death of the estate owner. This is of importance if continued premium gifts to an ILIT must be made to keep the policy in force all the way until death. The durable power holder would have to make premium gifts on behalf of the incapacitated estate owner.  Therefore, it is critical that the power holder have clear and specific authority in the durable power document to make these gift transfers.

Several Tax Court cases and IRS Rulings have held that a Durable Power of Attorney document must contain specific clauses which allow the power holder (attorney in fact) to make gifts of the incapacitated person’s property for purposes of the gift tax annual exclusion, the lifetime gift exemption, or the generation skipping exemption. If the document is silent with respect to this gifting power, then the power holder is presumed NOT to have the power to make gifts. This lack of power could cause a no-lapse UL or SUL type of policy to lapse quickly for non-payment of required annual premium.

A number of U.S. Tax Court cases basically have taken the position that, in the absence of state law to the contrary, the power holder does NOT have the authority to make gifts of the incapacitated person’s property where that authority is not expressly conferred in the document.  Most states also support this view with state statutory laws.

In addition to the power to make gifts, a good Durable Power of Attorney document can allow the power holder to perform several other important legal and financial functions:

• The estate owner must have sufficient mental capacity to execute the Durable Power document in the first place. This mental capacity is much the same as whether a person has the mental capacity to execute a will.
• The power to acquire life insurance on the lives of family members of the grantor of the Durable Power in whom the grantor has an insurable interest
• The power to retain any investments and to change and vary the form of any investments owned by the estate owner
• The power to invest in fixed and variable annuities and stocks, bonds and mutual funds as the power holder deems advisable including cash and money market accounts
• The power to sell, exchange or convey any property owned by the grantor of the Durable Power
• The power to manage, operate, mortgage and lease any real estate of the grantor
• The power to continue and to operate any business entity where the grantor owns shares in that entity
• The power to compromise and settle any legal claim due to the grantor or against the grantor
• The power to borrow money for any purpose connected with the protection, preservation and improvement of the grantor’s assets
• The power to employ agents such as attorneys, accountants, investment professionals and real estate brokers whose services may be required to administer the assets of the grantor
• The power to make gifts or gratuitous transfers to a spouse, descendants or charitable organizations. The maximum gift permitted each year to a non-charitable donee shall normally be limited to the maximum gift tax annual exclusion permitted under IRC Section 2503(b) and the unlimited educational and medical expense gifts permitted under IRC Section 2503(e). However, for estate planning purposes the power holder may make additional gifts up to an amount equal to any remaining lifetime gift exemption as permitted by IRC Section 2505(a), as amended from time to time.
• The grantor should also designate a successor power holder in case the original power holder dies, resigns or becomes incapacitated themselves.

Case example of no-lapse SUL policy owned by an ILIT:   

Mr. and Mrs. Jones created an ILIT for the benefit of their three children to be the owner and beneficiary of a $1,700,000 no-lapse guaranteed SUL policy fourteen years ago when they were each 72 years old. They also executed a Durable Power of Attorney document which permits their power holder daughter to make gifts on their behalf. They have gifted the guaranteed annual premium of $39,000 each year to the trust using their “Crummey” power gift tax annual exclusions. A cumulative total of $546,000 has already been gifted to the ILIT for premiums.  The nominal account cash value of the policy has fallen to $0. Mr. Jones died three years ago and Mrs. Jones (now age 86) has recently been placed into an extended care facility and requires her Durable Power holder daughter to manage her financial affairs.

It is critical that the power holder daughter continue to make the $39,000 annual premium gifts to the ILIT to keep the $1,700,000 no-lapse SUL policy in force. If the policy ever lapsed for non-payment of premium because the cash gifts were not made to the ILIT, the valuable income and estate tax free benefit of $1,700,000 would be lost to the heirs.

Summary

BSMG Advanced Sales can provide a specimen Durable Power of Attorney document that includes the power to make annual gift exclusion and lifetime exemption gifts. This gifting power is extremely important. It will permit the power holder (attorney in fact) to make sure that valuable policies owned by ILITs stay in force to provide an income and estate tax free death benefit.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net            

The post Durable Power of Attorney & No-Lapse Universal Life Insurance Owned by ILITs appeared first on BSMG.

IRC Section 1035 provides that exchanges into life insurance or annuity contracts with Long Term Care (LTC) riders will be income tax free because these riders are treated as  LTC contracts under IRC Section 7702B(e). These Section 1035 tax free exchange provisions positively impact so-called linked benefit life insurance-LTC products and linked benefit annuity-LTC products.

These products fall into 2 major categories which provide flexibility for case design:

• Single deposit or flex-pay life insurance products with an LTC rider.
  Life insurance death benefits are income tax free.  Lifetime LTC rider benefits paid on these contracts are also income tax free (IRC Section 7702B(e)), but will reduce the net life insurance death benefit to a minimum residual amount.

• Single deposit non-qualified deferred annuity products with LTC rider.
  Lifetime cash withdrawals from the deferred annuity will still be treated as Last In First Out (LIFO) income on gain in excess of cost basis. Death benefits will still be treated as taxable LIFO income in respect of decedent (IRD) on gain in excess of cost basis. However, lifetime LTC rider benefits will be income tax free (IRC Section 7702B(e)). The full deferred annuity account value will first be reduced to zero to pay LTC benefit claims before the remaining tax free LTC rider benefit claims are paid.

Here are the key Section 1035 exchange provisions that make these opportunities possible:

1. Life insurance exchanges into a life insurance contract with an LTC rider is defined as a life insurance to life insurance exchange for Section 1035 purposes (IRC Section 1035(b)(3))
   
   This means that existing life insurance contract cash values can be exchanged tax free into a linked benefit life insurance-LTC contract (single deposit or annual flex pay).  Only complete life insurance to life insurance exchanges are permitted …. i.e. the old contract must cease to exist. For flex-pay exchanges, a trail of annual premiums may be paid out of pocket by the policy owner in addition to the lump sum exchange amount from the old life insurance contract.The possibility of a 1 for 2 Section 1035 life insurance to life insurance exchange also exists. In this case, a traditional UL policy without an LTC rider could be one of the new contracts.  The other new contract could be a linked benefit life insurance-LTC contract (single deposit). Carryover cost basis on the exchange to the two new contracts will be allocated proportionally.
2. Annuity exchanges into an annuity contract with an LTC rider is defined as an annuity to annuity exchange for Section 1035 purposes (IRC Section 1035(b)(2))
   
   This means that existing deferred annuity account values can be exchanged tax free into a linked benefit deferred annuity-LTC contract (single deposit).         Also, since this type of exchange is considered to be an annuity to annuity exchange, partial exchanges from one annuity contract to another annuity contract are already permitted under the guidance of Rev. Rul. 2003-76 and Rev. Proc. 2011-38. Carryover cost basis will be allocated proportionally between the old and new contracts.

Cost basis tracking will be important for both life insurance-LTC and annuity-LTC linked benefit products.

• The Code provides rules for using cash value or account value of linked benefit products to pay the monthly charges (costs) for the LTC rider. These charges will be totally excluded from gross income and will simply reduce the cost basis of the insurance-LTC contract or annuity-LTC contract. However, the contract cost basis cannot fall below zero (IRC Section 72(e)(11)(A)(B)).

1035 Exchange Options for Standalone LTC and Guaranteed UL with LTC Rider

On another important issue regarding LTC Section 1035 exchanges, the IRS has issued additional tax guidance regarding partial exchanges involving annuities and Stand-Alone  individual LTC products.

• In Notice 2011-68, IRS allowed a series of annual partial tax free exchanges from a deferred annuity contract to fund annual premiums for a stand-alone LTC contract. This method can work well administratively when both the deferred annuity contract and the stand-alone LTC contract are issued by the same carrier.

Finally, annual premium or limited pay guaranteed universal life (GUL) insurance products with a qualified LTC rider are available for Section 1035 exchanges

• Life insurance death benefits are income tax free. Lifetime LTC benefits paid on these contracts are also income tax free (IRC Section 7702B(e)) and reduce the death benefit dollar for dollar.
• This tax free Section 1035 exchange option is available for both GUL with LTC rider and Survivorship GUL with a joint LTC rider

BSMG life insurance, annuity, and LTC advisors can provide access to a wide variety of linked-benefit LTC, standalone LTC, and GUL-LTC type of products from our competitive carriers.  Contact us today for a policy review of your client’s insurance or annuity contracts to see if a product with an LTC type of rider may provide a more flexible and more efficient combination of protection benefits.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net

The post Linked Benefit Products Offer Great Section 1035 Exchange Options appeared first on BSMG.

Often a policy review of your client’s existing life insurance and annuity contracts will conclude that a more cost efficient contract with better guarantees and rates of return makes sense. This will cause a producer to seek a potential transfer of the existing cash values to a new contract via a tax free Section 1035 exchange.

IRC Section 1035 tax-free exchanges of life insurance and annuity contracts must be carefully handled to insure a smooth transfer of funds from the old carrier to the new carrier. Of course, new medical underwriting must take place for a life insurance exchange. The health of the insured may have changed between the time the original policy was issued and the potential Section 1035 exchange.  Here are 5 important guidelines to keep in mind.

1. Possible Exchanges Where the Contract Owner is the Same Before and After the Exchange

• Life insurance can be exchanged for life insurance
• Life insurance can be exchanged for an annuity. This includes exchanges to either a deferred annuity or a single premium immediate annuity (SPIA)
• A deferred annuity can be exchanged for another annuity. This includes exchanges to either another deferred annuity or a SPIA
• An annuity CANNOT be exchanged for life insurance.

2. Types of Contracts that Can Be Exchanged with the Same Insured or Annuitant

• Single life to single life
• Single life to single annuitant
• Survivorship life to survivorship life
• Survivorship life (one insured deceased) to single life
• Single annuitant to single annuitantThe following exchanges DO NOT relate to the same insured(s), so will NOT achieve a tax-free transfer:
• Single annuitant to joint annuitant
• Single annuitant to single annuitant

3. Exchange of Life Insurance Policies with Loans

You must be careful when exchanging policies with loans that are in a gain position. A policy is in a gain position if the total cash value is greater than the adjusted cost basis.

• If the loan is extinguished (discharged) on the exchange, the lesser of the loan or the gain in the policy will be taxable income to the policy owner. This will generate a Form 1099-R from the carrier.
• If the loan is carried over on the exchange to the new carrier, the exchange will be accomplished tax free. However, the new policy will be issued with an outstanding loan right from the start. Many carriers have loan to value limits that must be met before they will accept a Section 1035 carry over loan.

4. Multiple Contract Exchanges

Multiple policies with the same owner and the same insured can be exchanged for a new policy. And one policy can be exchanged for multiple new policies. The cost basis of the contracts will be carried over to the new carrier and adjusted cumulatively (i.e. 2 for 1; 3 for 1) or proportionally (i.e. 1 for 2; 1 for 3) as the case may be.

5. Important Administrative Issues

Finally, be careful with the paperwork to complete a Section 1035 exchange. Carriers want the ownership to match exactly between the Section 1035 exchange form of the new carrier and the actual owner(s) of record with the old carrier. Otherwise, the old carrier may not process the exchange until the “title” ownership matches exactly. This is especially important when existing policies owned by an Irrevocable Life Insurance Trust (ILIT) are being exchanged.

Also, if a different policy owner is desired for the new policy, a change of ownership form must be executed. This change of ownership could take place either before or after the exchange depending on the specific facts of each case.

Contact your BSMG Life or Annuity Advisor when considering a Section 1035 exchange from one carrier to another carrier. Your BSMG Advisor will work with BSMG Case Managers and BSMG Advanced Sales to assure that the transfer of funds is handled in an expedited manner.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net

The post IRC Section 1035 Exchanges Require Special Attention appeared first on BSMG.

With the recovery of the equities markets after the economic downturn of 2008-2009, it is common for successful business owners, professionals, and other individuals to have more than $1,000,000 in their IRA account.

Many of these IRA owners have multiple sources of income as they approach their retirement years. These sources could include continued earned income from a profession, Social Security retirement benefits, K-1 pass-through income from ownership of S Corp or LLC entities, rental income from real estate, and other interest, dividends, or capital gains from non-qualified financial assets.

These IRA owners understand that Required Minimum Distributions (RMDs) must be taken from their IRA starting when they turn 70 ½. The question that typically arises in their financial planning is what to do with the after-tax amounts from their RMDs? For IRA owners with multiple sources of income, these after-tax RMDs are usually allocated as some form of inheritance to their heirs. Should these after-tax amounts simply be re-invested in their non-guaranteed financial asset portfolio or is there a more tax efficient way to re-allocate these funds that could provide a larger inheritance to their family?

The concept that can provide a larger after-tax inheritance is commonly known as the Inherited IRA Legacy Plan where after-tax RMDs are allocated to an annual premium for a no-lapse UL or no-lapse SUL life insurance product.

The actuarial leveraging and income tax-free life insurance death benefit can provide a larger inheritance by life expectancy and beyond than simply re-investing the after-tax RMDs in an asset portfolio with taxable yields. This is especially true in the continuing low-interest economic environment for fixed financial assets.

A Basic Blueprint for the Inherited IRA Using Life Insurance

Here are the steps of the inherited IRA transaction to provide a leveraged tax-free fund for heirs in the form of life insurance:

First, create an income stream from the IRA by taking distributions from the IRA. An IRA owner doesn’t need to wait until age 70 ½ to take distributions from an IRA. Some IRA owners may wish to wait until 70 ½ while others may find it beneficial to start distributions prior to 70 ½. Starting prior to 70 ½ may work when coupled with a life insurance program because of the usual higher premium cost of waiting. Also, the onset of certain medical conditions as we get older that may result in less favorable underwriting may be a good reason to consider starting IRA distributions prior to 70 ½.

The income stream from the IRA is taxable, but the after-tax dollars can be used for a premium on either personally owned life insurance or insurance owned by an irrevocable life insurance trust (ILIT).

The decision on personal ownership or ILIT ownership will depend on factors such as the size of the IRA gross estate in relation to the $5.49 million (single) and $10.98 million (married) federal estate tax exemption in 2017. Also, the simple size of the death benefit may dictate ownership by an ILIT whether or not the IRA owner has an estate large enough to worry about federal estate taxes. Certainly, many IRA owners may be exposed to state death taxes because of the lower state death tax exemptions of many states that still levy state death taxes.

Who shall be named as the beneficiary of the life insurance? Shall it be the children of the IRA owner outright or an ILIT for their benefit? Or shall it be an ILIT for the benefit of the grandchildren of the IRA owner?

Who shall be named as the beneficiary of the IRA? Shall it be the children of the IRA owner outright or a trust for their benefit so the inherited IRA can be paid over the children’s life expectancy? Or shall it be a trust for the benefit of the grandchildren so the inherited IRA can be paid over the longer life expectancy of the grandchildren?

Case Study of Inherited IRA Using After-Tax IRA Distributions for Life Insurance versus Using After-Tax Distributions for Alternative Fixed Financial Asset

Facts of Case Study:

Client and spouse are 71 and 70 respectively and have a current gross estate of $5,000,000. The client owns an IRA worth $1,000,000 and must start taking RMDs. They have other sources of retirement income including Social Security benefits, income from rental properties, and interest, dividends, and capital gains from their non-qualified asset portfolio. They ask you, their financial professional, to make a study of what to do with the after-tax RMDs that must start to be distributed from the IRA. Their combined federal and state income tax bracket is estimated at 35%. They feel that an after-tax return on their non-qualified asset portfolio is 5% going forward.

SCENARIO #1

Place After-Tax RMDs in an Asset Allocation Portfolio at 5% After-Tax Rate of Return (ROR)

• The factor from the Uniform Distribution Table for a 71-year-old is 26.5. This means the RMD on the $1,000,000 IRA account will be $37,736. In a 35% tax bracket, the after-tax amount is $24,528.
• This after-tax amount of $24,528 will be re-allocated each year into the non-qualified asset portfolio with an assumed after-tax ROR of 5%.
• The joint life expectancy of a male 71 / female 70 from the government joint life expectancy table is about 20 years.
• An annual deposit of $24,528 into a non-guaranteed financial asset for 20 years at 5% after-tax ROR would provide a fund value of $852,000. This is the hypothetical non-guaranteed amount that would be inherited by the heirs of the client and spouse.

SCENARIO #2

Place After-Tax RMDs in a No-Lapse Survivorship Universal Life (SUL) Policy for Male Age 71 (Standard NS) and Female Age 70 (Standard NS)

• The factor from the Uniform Distribution Table for a 71-year-old is 26.5. This means the RMD on the $1,000,000 IRA account will be $37,736. In a 35% tax bracket, the after-tax amount is $24,528.
• This after-tax amount of $24,528 will be re-allocated each year into a premium for a no-lapse SUL insurance policy issued by a competitive carrier.
• An annual premium of $24,528 will purchase a guaranteed SUL death benefit of $1,172,000 right from the beginning. This is the tax-free amount the heirs would receive at the death of the survivor of the client and spouse. The IRR at year 20 joint life expectancy is 7.72%. In a 35% tax bracket, the pre-tax equivalent IRR is 11.88%.
• Instead, if very good health was able to provide a Male 71 Preferred NS and a Female 70 Preferred NS medical underwriting result, the $24,528 annual premium would purchase a guaranteed SUL death benefit of $1,352,000. The IRR at year 20 joint life expectancy is 8.90%. In a 35% tax bracket, the pre-tax equivalent IRR is 13.69%.

Summary of Benefits for Inherited IRA Plan with Life Insurance

The benefits of channeling after-tax IRA distributions into guaranteed no-lapse life insurance are significant. When compared to the taxable yields of alternative fixed financial assets (Money markets, bank CDs, bond funds, U.S. government securities), in the continuing low-interest environment, the net results are truly outstanding.

1. The net inheritance to the heirs of the IRA- SUL life insurance plan shown above is hypothetically improved by about $320,000 at joint life expectancy (20 years) with standard medical underwriting when compared to alternative financial assets. The net inheritance to the heirs of the IRA-SUL life insurance plan is hypothetically improved by about $500,000 at joint life expectancy (20 years) with preferred medical underwriting when compared to alternative fixed financial assets.
2. The SUL life insurance provides a guaranteed no-lapse benefit versus a non-guaranteed accumulation value of the alternative fixed financial asset. The non-guaranteed cross-over point where the non-guaranteed financial asset hypothetically exceeds the guaranteed standard underwriting SUL insurance death benefit does not occur until year 25 when the younger insured, if still alive, is age 95. The non-guaranteed cross-over point where the non-guaranteed financial asset hypothetically exceeds the guaranteed preferred underwriting SUL insurance death benefit does not occur until year 27 when the younger insured, if still alive, is age 97.
3. The SUL life insurance could be owned by an ILIT so that the death benefit is estate tax-free for state death tax purposes. The $5,000,000 taxable estate in our case study above would generate about $300,000 of state death taxes in certain states which still uses the tax table from IRC Section 2011. Part of the SUL death benefit could be used to offset these state death taxes with the rest of the death benefit managed by the trustee for the benefit of trust beneficiaries.

The remaining IRA value at the death of the client is paid outright to children or to a separate trust for the benefit of children or grandchildren as an inherited IRA. The RMDs using the Single Life Table can be stretched over the remaining life expectancy of the children or grandchildren depending on the dispositive provisions of the trust document. Using this inherited IRA stretch method, the income taxes to the heirs are spread out and paid annually over many years into the future rather than paid in a lump sum and taxed all in one tax year.

Contact your BSMG Advisor if you have a client that has significant IRA values they never expect to use during their lifetime. Your BSMG Advisor can work with BSMG Advanced Sales to craft a plan to enhance the legacy of your client’s IRA using guaranteed no-lapse life insurance.

Russell E. Towers, JD, CLU, ChFC
Vice President, Business & Estate Planning
russ@bsmg.net

The post Creating an Inherited IRA Legacy Plan with Life Insurance Funded by After-Tax Distributions appeared first on BSMG.

Most assets of a married couple are considered to be “countable assets” for purposes of qualifying for Medicaid extended care benefits. This includes all assets held jointly by the couple as well as any assets held in the sole name of either spouse (including retirement plans like IRAs and non-qualified deferred annuities). Often, these combined assets must be spent down to the Community Spouse Resource Allowance (CSRA) of $120,900 in 2017 for the healthy spouse before the institutionalized spouse will be eligible to receive Medicaid benefit payments.

Also, the equity in primary residence is generally exempt for the healthy stay at home spouse. Given these modest exemptions, is there any planning concept that may be utilized to protect the assets of the couple from being depleted so that their heirs may receive an inheritance?

The answer is yes! The use of short term “period certain only” Single Premium Immediate Annuity (SPIA) remains a viable tool in assisting some of your clients to qualify for Medicaid benefits while protecting asset values for their heirs.  A SPIA that is owned by and payable to the healthy stay at home community spouse will generally NOT be considered a “countable asset” for purposes of qualifying the institutionalized spouse for Medicaid.  The SPIA is considered to be the separate income stream of the healthy stay at home spouse and not subject to being liquidated to pay extended nursing costs for the institutionalized spouse.

Let’s look at a simple case study to illustrate the concept:

Case Study
(Rules vary by state, always consult an elder planning attorney when speaking about Medicaid planning):

• Married Couple, Both Age 80
• Husband, the “Institutionalized” spouse , has been admitted to a nursing home, and wishes to apply for Medicaid benefits
• Wife is the healthy or “stay-at-home” community spouse
• The couple owns $200,000 of excess liquid assets beyond the 2017 Community Spouse Resource Allowance (CSRA) of $120,900 for a total of $320,900 of countable assets.
• There is $400,000 of net equity in the primary residence

Goals

• Make the institutionalized spouse eligible for Medicaid now
• Provide current income for the healthy spouse while providing an option to transfer excess funds via gift to the adult children
• Plan for potential future Medicaid eligibility of the healthy spouse

Normally, this couple would have to spend-down their excess assets in order to be eligible for Medicaid.  Since the enactment the Deficit Reduction act of 2005 (effective February 8, 2006), any transfers or gifts are subject to a 5 year look-back that starts on the application date for Medicaid benefits.

There is a viable strategy to avoid spending down or being subject to the look-back. The healthy spouse purchases a 5 year period certain only SPIA ($200,000 deposit) and receives about $3,200 per month (this type of annuity pays for 60 months, then stops).  The annuity is set up with an endorsement to the contract to be irrevocable, non-assignable, and non-transferable to comply with the Medicaid rules for immediate annuities.

The state must be listed as the remainder beneficiary, after the healthy spouse who is receiving the current income. The state has a claim to the remaining income payments if the healthy spouse does NOT outlive the SPIA benefit period, in this case, 60 months.

After the SPIA policy is issued, and the free-look period expires, the institutionalized spouse may apply for Medicaid benefits immediately, without being subject to the 5 year look-back. The healthy spouse can spend the income, and can gift any excess income to children or grandchildren ($14,000 annual gift exclusion allowed from spouse to each family member). By purchasing the SPIA and gifting excess income, the couple has accomplished three things:

• Obtain eligibility for Medicaid benefits for the institutionalized spouse – no 5 year look back on the purchase of the SPIA.
• Provide current income to the healthy spouse for living expenses; anything spent is not countable for the healthy spouse’s future Medicaid eligibility
• Optimize future eligibility of healthy spouse for Medicaid by gifting excess income to family members. Each annual gift will start a 5 year look-back towards the healthy spouse’s future eligibility for Medicaid (i.e. year 1 gift is safe by year 6; year 2 gift is safe by year 7 etc).

In this case, the shorter the term certain of the SPIA, the better, as the excess income, if any, needs to be gifted to family members sooner rather than later. Each gift starts its own 5 year look-back, which is an important factor to determine the healthy spouse’s future eligibility for Medicaid benefits.

Step-by-Step Summary of the “Medicaid SPIA” Process

For ease of understanding, here is a basic step-by-step summary of the Medicaid SPIA process which is designed to convert countable assets for Medicaid qualification purposes into a non-countable income stream of the healthy spouse:

Step 1: Make an asset inventory of all liquid and non-liquid assets of the client and spouse and the current value of each asset.  This includes ALL assets in the husband’s sole name, ALL assets in the wife’s sole name, and ALL jointly owned assets. This includes all types of qualified retirement plans such as IRAs, all non-qualified assets such as mutual funds, all non-qualified annuities, and all cash value of life insurance.

Step 2:  Determine the value of the primary residence. In 2017, the home equity is exempt up to either $560,000 or $840,000 depending on the state exemption limit. In addition, $120,900 of any other listed assets are considered to be exempt as the Community Spouse Resource Allowance (CSRA).

Step 3: Consider the purchase of a so-called Medicaid compliant short-term SPIA to convert all countable assets above the 2017 $120,900 CSRA into a non-countable income stream of the healthy community spouse.  The short-term SPIA (5 years) will be irrevocable and non-assignable by contract endorsement.  The state Division of Medicaid Assistance should be named as the primary beneficiary, “as its interest may appear” if the healthy spouse dies before the end of the 5 year period certain term.

Step 4: Clients apply for Medicaid benefits for the institutionalized spouse listing only the home equity and $120,900 (CSRA) of any other assets.  Disclose the short-term period certain SPIA on the application for Medicaid benefits as non-countable income of the healthy spouse.

Step 5: After the healthy spouse receives each annual SPIA payment, make irrevocable annual gifts to the adult children over 5 years of amounts not needed for current fixed expenses.  The gift in year 1 will be safe from the look-back rule by year 6; the gift in year 2 will be safe from the look-back rule in year 7 etc.

The advice of a qualified elder planning attorney is vitally important when Medicaid planning is involved, since rules vary somewhat by state.  Clients should work with both their law firm and financial advisor to make sure everyone is on the same page and the plan has sound legal standing.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net

The post Medicaid Planning and SPIAs appeared first on BSMG.

When an individual dies, every piece of property owned by that deceased individual must be transferred to a new owner.  Both real property and personal property (tangible and intangible) can pass to the decedent’s heirs in a number of ways.  Property can take on many forms, such as shares of a closely held business (i.e. corporation, limited liability company, partnership), real estate, bank accounts, stocks, bonds, mutual funds, life insurance, annuities, qualified retirement plans (401(k), profit sharing, SEP, defined benefit), IRAs, Roth IRAs, 403(b) plans, 457(b) plans, non-qualified deferred compensation plans, notes and loans receivable, stock options, collectibles, jewelry, cash, etc.

Being able to discuss the post-death transfer of all types of property with your clients can give you an edge as a trusted professional advisor.  Many clients are under the mistaken impression that all their property will pass under the terms of their wills.  Nothing could be further from the truth.  Each and every piece of property owned by a client at death must be inventoried, valued, and distributed according to the property transfer laws of descent and distribution.

Nine Ways Property Can be Legally Transferred at Death

• Intestate … property owned in a sole name (individually) is considered probate property and will pass according to statutory state intestacy law when there is no will. The final distribution must be approved by the Probate Court
• Will … property owned in a sole name (individually) is considered probate property and will pass to heirs according to specific directions in a legally executed will. The final distribution must be approved by the Probate Court
• Living Trust … the trust may be revocable or irrevocable. A revocable living trust automatically becomes irrevocable upon the death of the grantor. Property owned in the legal name of the trustee passes to trust beneficiaries according to the terms of the trust.  The remainder beneficiaries of the trust may be individuals or another trust.  Property owned by a living trust will NOT be subject to probate.
• Testamentary Trust … property owned in a sole name (individually) first passes through the will, and then into the trust by specific language in the will. The remainder beneficiaries of the trust may be individuals or another trust.  The property passing through the will is probate property and the final distribution to the testamentary trust must be approved by the Probate Court.
• Contract in Lifetime … a classic example of a contract in lifetime is a buy sell business transfer agreement. At the death of a business owner, the shares of the business are purchased from the estate by a third party (i.e. corporation or surviving shareholder).  This transaction will NOT be subject to probate.Another good example is a contingent owner designation of a third party owned life insurance policy.  Upon the death of the policy owner while the insured is still alive, the ownership of the policy will automatically transfer to the contingent owner and will NOT be subject to probate.

• Beneficiary Designations … life insurance, annuities, qualified retirement plans, IRAs, non-qualified deferred compensation benefits, and transfer on death (TOD) designations of non-qualified investment accounts all pass to the designated beneficiary and will NOT be subject to probate. The designated beneficiary may be an individual or a trust.
• Joint Tenancy with Right of Survivorship (JTWROS) … this undivided interest in property passes automatically by operation of law to the surviving joint owner and will NOT be subject to probate
• Tenancy in Common … this undivided interest in property owned in a sole name (individually) with other tenant in common owners passes according to specific directions in the will of the deceased or by the intestacy laws of the state if there is no will. The tenant in common interest is probate property and final distribution must be approved by the Probate Court.
• Qualified Disclaimer … if the recipient of any type of property executes a qualified disclaimer within nine months of the death of the owner of probate property, the property in question will instead pass to the remaining beneficiaries of a probate estate. For life insurance, annuities, qualified retirement plans, and IRAs, the property in question will pass to the contingent beneficiary when the designated primary beneficiary disclaims.  Sometimes a “double disclaimer” needs to take place in order for the disclaimed property to be transferred to the desired heir.

Each and every asset owned by a deceased individual must pass through one of the property transfer methods described above.  Financial professionals should record and update an accurate asset inventory for their clients which lists current value, asset title, and whether the asset will pass through the probate court process or not.  To help you gather detailed client information for wealth distribution purposes, BSMG has created an Estate Planning Factfinder for your use.  This will help you organize financial information so you can provide more accurate recommendations to your clients.  This Estate Planning Factfinder and all other BSMG Factfinders can be accessed on the BSMG Website at www.bsmg.net.

State Estate Taxes and IRD Income Taxes

Also, certain states have state estate taxes that must be paid.  Generally, states that de-coupled from the federal estate tax system so they could continue to levy death taxes on their deceased residents have progressive state death taxes ranging from about 5% up to 16% depending on the size of the taxable estate.  There is currently a federal estate tax deduction for any state death taxes actually paid.  Examples of de-coupled states which levy state death taxes include Rhode Island, Massachusetts, Connecticut, New York, Maine, and Vermont.

States that remained coupled to the federal estate tax system currently have no state death taxes at all.  Examples of zero-tax coupled states include New Hampshire, Virginia, Florida, Texas, and California.  Financial professionals should advise their clients whether or not state death taxes may be part of their planning picture depending on whether their state is a de-coupled state or a coupled state.

Finally, financial professionals should advise their clients whether or not there will be any post-death income taxes on certain financial assets.  This post-death income is known as “income in respect of decedent” (IRD).  Two major types of financial assets affected by this post-death IRD tax are qualified retirement plans (i.e. IRA and 401(k)) and the deferred gain amount in excess of cost basis for non-qualified deferred annuities.

Plan beneficiaries of these assets will report the receipt of these post-death taxable amounts as ordinary income on their own federal and state personal income tax returns.  There are certain options available under the Internal Revenue Code and Regulations to spread out the IRD post-death taxation over a number of years after the account owner’s death if desired.  Generally, these rules allow up to 5 years as a post-death distribution option or, conversely, a post-death distribution option over the life expectancy of the beneficiary.  Smaller accounts may opt for the 5 year plan whereas larger accounts may find the life expectancy method more suitable to their needs.  Clients should consult their financial professionals and tax advisors to explore these post-death inherited IRA or inherited non-qualified annuity distribution options.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
russ@bsmg.net

The post How Different Types of Property are Legally Transferred at Death appeared first on BSMG.

The use of an Indemnity LTC Rider is crucial to keep the life insurance death benefit estate tax free. That’s because any rider benefits will be paid only to the ILIT as policy owner, and NOT used to pay extended care costs directly to the extended care provider. Since LTC benefit claims are paid only to the ILIT, this Indemnity LTC Rider does NOT create an incident of ownership in the UL policy. Any incidents of ownership in a life insurance policy causes the life insurance death proceeds to be included in the gross estate of the insured estate owner.

This important Indemnity LTC Rider contrasts with the so-called reimbursement style LTC riders. Reimbursement type of LTC riders pay extended care benefit payments directly to the provider on behalf of the insured. Most advanced planning commentators take the position that this reimbursement type of LTC rider on a UL policy owned by an ILIT is considered an incident of ownership for estate tax purposes that causes the life insurance death proceeds to be included in the gross estate of the insured.

Note: The tax reform proposals of President Trump include the repeal of federal estate taxes. ILITs may still be useful planning tools even if federal estate taxes are eliminated.

Client Profile:

Successful business owners, professionals, and wealthy individuals who have gross estates large enough to be exposed to:

• Federal estate taxes (assuming some form of federal taxes exist at death)
• State death taxes (assuming state taxes are levied in state of residence)
• Income in respect of decedent (IRD) income taxes on their QRP/IRA assets.

Key Phrases to Use with Your Client:

• Income and estate tax-free death benefit to offset estate and income taxes due at your death.
• Special indemnity Long Term Care rider that provides tax free restoration of personal funds used to pay extended care expenses.
• A guaranteed no-lapse Universal Life policy with an extremely competitive Internal Rate of Return (IRR) out to life expectancy and beyond.
• Low present value cost provides protection against death and extended care expenses in the same product package.

Planning Options Available When Indemnity LTC Rider Benefits are Paid to an ILIT

Assuming that a no-lapse UL policy with an indemnity LTC rider is owned by an ILIT, here are some planning options available to the insured and family to either offset or pay for any extended care medical costs:

Option #1: Carrier makes income tax free LTC claim payments to the ILIT. ILIT keeps cash in the ILIT to be invested in a side fund.

• ILIT keeps LTC claim payments in the trust and invests in stock, bonds, mutual funds etc.
• This trust owned portfolio of financial assets is estate tax free.
  • Offsets extended care LTC costs paid out of pocket by the estate owner.
• The estate owner pays any LTC care costs out of pocket from other personal assets.
  • These LTC medical service payments reduce the gross estate for estate tax purposes by the amount of these out of pocket payments.
• At death, the life insurance proceeds paid to the ILIT from the base UL policy are income and estate tax free.

Option #2: Carrier makes income tax free LTC claim payments to the ILIT. ILIT loans cash to insured estate owner.

• ILIT makes a private loan to the estate owner.
  • An interest only note payable at the current AFR rate is executed between the trust and the estate owner.
• The estate owner uses the cash received from the loan to pay extended care LTC expenses.
• The estate owner makes annual interest payments on the note to the ILIT from other personal resources.
• At death, the estate of the deceased pays off the loan principal on the note to the ILIT from other estate assets and takes an estate tax deduction for debts paid from the estate on Line 2 of the Form 706 U.S. Estate Tax return [IRC Section 2053(a)].
• At death, the life insurance proceeds paid to the ILIT from the UL base policy are income and estate tax free.

Option #3: Carrier makes income tax free LTC claim payments to the ILIT. ILIT distributes cash to ILIT beneficiary (adult child).

• ILIT trustee uses discretionary authority granted in a well-drafted trust document to make distributions of trust principal to any one or more of the trust beneficiaries (adult children of insured estate owner)
• This cash distribution is a tax free distribution of trust principal to the adult child.
  • The character of the income (tax free LTC benefits) retains its character when distributed to trust beneficiaries.
• The adult child voluntarily (under no obligation) makes an unlimited gift tax exclusion gift of this cash on behalf of the parent to pay the LTC medical expenses of the parent under IRC Section 2503(e).
• At death, the life insurance proceeds paid to the ILIT from the UL base policy are income and estate tax free.

The indemnity type of LTC rider may either be a qualified LTC rider under IRC Sec 7702B, or an accelerated death benefit rider for chronic illness under IRC Section 101(g). Both types of indemnity riders pay income tax free benefit claim payments to the policy owner when triggered. Any tax free benefits paid under both types of riders reduces the life insurance death benefit dollar for dollar.

What type of protection product will match your client’s needs?

1. A stand-alone annual premium traditional LTC product
2. A linked-benefit single premium life insurance-LTC product
3. An annual premium no-lapse UL life policy with a reimbursement type of LTC rider
   or
4. An annual premium no-lapse UL policy with an indemnity type of LTC rider.

Contact Joe Savastano for your client’s needs.

Russell E. Towers   JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net

The post Universal Life Policy With Indemnity LTC Rider Owned By An ILIT appeared first on BSMG.

IRC Section 1035 provides exchanges into life insurance or annuity contracts with Long Term Care (LTC) riders to be income tax free and treated as LTC contracts under IRC Section 7702B(e).  The tax free exchange provisions in Section 1035 positively impact so-called linked benefit life insurance-LTC products and linked benefit annuity-LTC products.

These products fall into 2 major categories which provide flexibility for case design:

1. Single deposit or flex-pay life insurance products with a LTC rider.

Life insurance death benefits are income tax free.  Lifetime LTC rider benefits paid on these contracts are also income tax free (IRC Section 7702B (e)), but will reduce the net life insurance death benefit to the minimum residual amount.

2. Single deposit non-qualified deferred annuity products with a LTC rider.

The full deferred annuity account value will first be reduced to zero to pay LTC benefit claims before the remaining tax free LTC rider benefit claims are paid. Lifetime LTC rider benefits will be income tax free (IRC Section 7702B (e)). Lifetime cash withdrawals from the deferred annuity will still be treated as LIFO income on gain in excess of cost basis.  Death benefits will still be treated as taxable LIFO income in respect of decedent (IRD) on gain in excess of cost basis.

Key Section 1035 exchange provisions that make these opportunities possible:

• Life insurance exchanges into a life insurance contract with a LTC rider is defined as a life insurance to life insurance exchange for Section 1035 purposes (IRC Section 1035(b)(3))…

Meaning that existing life insurance cash values can be exchanged, tax free, into a linked benefit life insurance-LTC contract (single deposit or annual flex pay).  Only complete life insurance to life insurance exchanges are permitted, i.e. the old contract must cease to exist.  For flex-pay exchanges, a trail of annual premiums may be paid out of pocket by the policy owner in addition to the lump sum exchange amount from the old life insurance contract.

The possibility of a one for two Section 1035 life insurance to life insurance exchange also exists.  In this case, a traditional UL policy without a LTC rider could be one of the new contracts and the other new contract could be a linked benefit life insurance-LTC contract (single deposit).  Carryover cost basis on the exchange to the two new contracts will be allocated proportionally.

• Annuity exchanges into an annuity contract with a LTC rider is defined as an annuity to annuity exchange for Section 1035 purposes (IRC Section 1035(b)(2))…

This means that existing deferred annuity account values can be exchanged tax free into a linked benefit deferred annuity-LTC contract (single deposit).

Since this type of exchange is considered to be an annuity to annuity exchange, partial exchanges from one annuity contract to another annuity contract are permitted under the guidance of Rev. Rul. 2003-76 and Rev. Proc. 2011-38.  Carryover cost basis will be allocated proportionally between the old and new contracts.

Cost basis tracking will be important for both life insurance-LTC and annuity-LTC linked benefit products.

The Code provides rules for using cash value or account value of linked benefit products to pay the monthly charges (costs) for the LTC rider.  These charges will be excluded from gross income and will reduce the cost basis of the insurance-LTC contract or annuity-LTC contract.  However, the contract cost basis cannot fall below zero (IRC Section 72(e)(11)(A)(B)).

1035 Exchange Options for Standalone LTC and Guaranteed UL with LTC Rider

• Another significant issue concerning LTC Section 1035 exchanges is that the IRS has issued additional tax guidance for partial exchanges involving annuities and stand-alone individual LTC products.

In Notice 2011-68, the IRS allowed a series of annual partial tax free exchanges from a deferred annuity contract to fund annual premiums for a stand-alone LTC contract.  This method can work well administratively when both the deferred annuity contract and the stand-alone LTC contract are issued by the same carrier.

• Lastly, Annual Premium or Limited Pay Guaranteed Universal Life (GUL) insurance products with a qualified LTC rider are available for Section 1035 exchanges.

Life insurance death benefits are income tax free.  Lifetime LTC benefits paid on these contracts are also income tax free (IRC Section 7702B(e)) and reduce the death benefit dollar for dollar.

This tax free Section 1035 exchange option is available for both GUL with LTC rider and Survivorship GUL with a joint LTC rider

BSMG life insurance, annuity, and LTC advisors can provide access to a wide variety of linked-benefit LTC, standalone LTC, and GUL-LTC type of products from our competitive carriers.  Contact us today for a policy review of your client’s insurance or annuity contracts to see if a product with an LTC type of rider may provide a more flexible and more efficient combination of protection benefits.

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net

The post Linked Benefit Products Offer Flexibility for Section 1035 Exchange Options appeared first on BSMG.

 (Assumes Marital-Credit Shelter Trust is Created at First Death and “Portability” of Estate Tax Exemption is NOT Elected)
2018

A) Marital Deduction Portion: (Remaining principal and growth included in gross estate of surviving spouse)

1. Outright [will (probate), joint tenancy, beneficiary designation]
   • Absolute dominion and control of asset by spouse

2. General Power of Appointment Trust (GPA) (“A”)
   • All income and principal can be demanded at anytime by spouse

3. Qualified Terminable Interest Trust (Q-TIP) (“A”)
   • Income only for life to spouse, principal to children

4. Qualified Domestic Trust (Q-DOT) (“A”) (non-citizen spouse)
   • Income only for life to spouse, principal to children
   • Must use a U.S. trustee to secure marital deduction

B) $11,180,000 Credit Shelter Portion: (Remaining principal and growth NOT included in  gross estate of surviving spouse)

1. Outright [will (probate), joint tenancy, beneficiary designation]
   • Absolute dominion and control of asset by children

2. Credit Shelter Trust (aka Family, By-Pass, “B”)
   • Income to spouse for life, remainder (principal) to children
   • Income to spouse for life, plus 5% of principal each year (non-cumulative), remainder (principal) to children.
   • Income to spouse for life, plus 5% of principal each year (non-cumulative), plus ascertainable standards (health, education, maintenance, support), remainder (principal) to children

Russell E. Towers  JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net

The post Marital Deduction/Credit Shelter Plan Design Options for Large Estates after Tax Cuts and Jobs Act of 2017 appeared first on BSMG.