1. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 1  Why a gift of life insurance?  May increase the donor’s spendable income  Donee is less inclined to surrender a life insurance policy for its cash value than to dispose of income producing property  Low gift tax cost  No gain for income tax purposes when the life insurance policy matures as a death benefit, even if the property was obtained as a gift  Client’s personal financial security diminished only by the transferred cash value  A gift of life insurance may be a way to assure the children of a first marriage of financial security and a share of their parent’s wealth in the event of a second marriage

2. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 2  Why a gift of life insurance? (cont’d)  To provide children with an amount greater than the unified credit equivalent during the lifetime of his spouse  The four questions:  Was there a gift, a gratuitous transfer for less than adequate and full consideration?  Was the gift completed?  What is the value of the gift?  Is there an exclusion or a deduction that can reduce or eliminate the taxable gift or a credit that can reduce or eliminate the tax on the gift?

3. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 3  Outright gifts of policies  Primary advantage – incredible leverage  The gift tax value of the lifetime transfer is considerable less than the death proceeds removed from the client’s estate  When is the gift completed?  Completed gift occurs at the moment every interest that the insured and/or the policyowner held is surrendered or otherwise assigned  Reversionary interests  Possibility of a reverter may allow a reduction in the value of a taxable gift assuming recognized actuarial standards can be applied to measure the value of the reversion  The conditioning of the right to receive proceeds on surviving the insured does not affect the completeness of the gift; it affects only the valuation of such gift.

4. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 4  Outright gifts of policies (cont’d)  Gifts of policies to revocable trusts are not completed gifts  Gifts of policies to an ILIT  Both the transfer of the policy and the subsequent payment of premiums are considered completed gifts  Absent special provisions, no annual exclusions will be allowable  Gifts to an IRC Section 2503(c) trust  Will qualify for the annual exclusion if  Policy values can be used for the minor’s benefit  Policy will pass to the minor at age 21 (or, if the minor dies prior to that date, to the beneficiary named in his will or to the person’s appointed by the minor during lifetime or by will)

5. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 5  Outright gifts of policies (cont’d)  Gifts to minors can qualify for the annual exclusion even if the child has no legal right to exercise ownership privileges under the policy and even if no guardian has been appointed  Gift to minors under UGMA (Uniform Gift to Minors Act) or UTMA (Uniform Transfers to Minors Act) will qualify for the gift tax annual exclusion  Clients making gifts of large policies should consider splitting the policy into smaller ones and giving one policy one year and the others in other years so that all gifts fall within the annual exclusion limits  Gifts of a policy from one spouse to another qualify for the gift tax marital deduction and eliminate any gift tax on interspousal transfers

6. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 6  Three party situations  One party owns a policy on the life of another and the proceeds are payable to a third party  Income and gift tax problems could arise  Example  W purchases $1,000,000 policy on H and names S as beneficiary  At the death of H, W is deemed to have made a $1,000,000 gift to S  Example  W purchases policy on H and names her revocable trust as beneficiary. The trust is to pay income to H, and upon his death proceeds go to children.  If H dies first (or perhaps if they die simultaneously), then W is deemed to have made a gift of the proceeds to their children

7. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 7  Three party situations (cont’d)  Example  H creates a revocable living trust. According to trust terms, income is payable to W for life. At W’s death, the trust property passes to children  W purchases a policy on H and names the revocable trust as beneficiary  Upon H’s death, W is deemed to have made a gift equal to the proceeds less the present value of her right to income for life from the trust  Solution: Where one party purchases a life insurance policy on the life of another, name the purchaser as both policyowner and beneficiary.

8. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 8  Payment of premiums on behalf of another  Payment of premiums considered a gift  Gift is the full premium paid  A reduction in the amount of the taxable gift would be allowed for the actuarial value of any interest in the policy’s benefits retained by the donor  Cash transfers to an irrevocable trust constitute a gift to the beneficiaries of the trust  Premium payments by one beneficiary of a trust is generally considered a gift to the other beneficiaries of the trust  If an individual assigns group term coverage to a beneficiary or a trust on behalf of one or more beneficiaries  Employer’s group term premiums are deemed gifts from the employee to the beneficiaries

9. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 9  Gift through settlement option  General power of appointment  Client died and proceeds payable to wife in a manner that provided she would only receive income on proceeds with balance to children at her death  Coupled with widow’s right to income was a general power of appointment that gave her the right to draw down unlimited amounts of principal at any time  To the extent that she failed to exercise that right, she would be making gifts to her children, the remainder persons

10. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 10  How is the gift valued?  Three types of gift transactions  Gift of an established policy in premium paying status  Value is equal to (a) the “interpolated terminal reserve” plus (b) the value of any “unearned premiums” less the amount of any outstanding loan.  Interpolated terminal reserve – reserve held by insured to meet its claims, but adjusted from the contract’s anniversary to the date of the gift  Unearned premium – value of the unearned portion of the last premium payment made to the insurer prior to the gift  Gift of a paid-up or single premium policy  Gift tax value is the single premium the insurer would charge at the time of the gift for a comparable contract of equal face amount on the life of the person the insured’s age at the time of the gift

11. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 11  How is the gift valued? (cont’d)  Three types of gift transactions (cont’d)  Gift of a policy just purchased  Gross premiums paid to date is the taxable value of the gift  Minimize gift tax implications by  Making gifts as close to the premium paying date as possible so as to minimize any unearned premiums  Borrow on the policy up to, but not more than, the client’s basis  Life insurance companies will provide a statement of the gift tax value of any of the three types of policies described above  There may be an increased gift tax valuation for policies on impaired risks, the terminally ill, or the uninsurable

12. Cash and Cash Equivalents Chapter 1 Tools & Techniques of Investment Planning Gift Taxation of Life Insurance Chapter 24 Tools & Techniques of Life Insurance Planning 24 - 12  Collection of the gift tax  The donee is liable for the full gift tax value to the extent it is not collected from the donor.  The donee’s liability is not limited to the cash value of the policy