1. © 2004 ME™ (Your Money Education Resource™) Estate Planning Chapter 11: Life Insurance in Estate Planning

2. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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