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