Individuals that may be subject to the Estate Tax in the future often consider using Irrevocable Life Insurance Trusts for the purpose of Estate Tax Mitigation.  Given that affluent individuals whose estates are larger than current exemption amounts are subject to the 45% Estate Tax, it is wise to use any means possible to attempt to mitigate this tax. 

The current Estate Tax exemption is $ 3.5 Million per individual and $ 7 Million per couple.  Meaning that if you have an estate that is $ 7 Million or less if you were to pass away today you would owe no Estate Tax, however, read on as this will change.  The current exemption of $ 3.5 Million is a large amount in light of previous exemptions and it is this author’s opinion that given the state of the economy and the Trillions of Dollars that the US Government is committing to the economic crisis that it is also an unsustainable one.  The current exclusion is $ 3.5 Million in 2009, $ 1 Million in 2010 and a repeal or sunset in 2011. A total repeal or sunset is highly unlikely and the Estate Tax or “Death Tax” is currently very much a hot topic in Washington with some Democrats siding with Republicans in an attempt to repeal or raise the limits.  However, political leanings aside, it is my forecast that the Estate Tax will return to the Clinton era levels of $ 1 Million.  This is again due to the overwhelming pressures of stimulus/bailout spending for the economy in addition to the Billions upon Billions committed or already spent in Iraq and Afghanistan.  There have been years of astronomical spending and the Government appears to be fairly quiet about how all of it is going to be paid for.  The Estate Tax is a 100 Billion Dollar question, and as we all know every 100 Billion counts.

What does all of this mean to the high net worth individual who wishes to protect his or her nest egg from predation by the IRS?  What it means is that we use any and every tool possible to attempt to mitigate the Estate Tax.  One of the most effective and efficient tools available for Wealth Transfer Management is the Irrevocable Life Insurance Trust.  How an Irrevocable Life Insurance Trust works is a Life Insurance policy is put inside of a Trust which transfers the proceeds of said Life Insurance Policy outside of the Grantors estate upon their passing thereby making the proceeds Estate Tax free.   Annual Gifts are made to the trust, with which the trustee can make premium payments.  An attempt is always made to keep these gifts within both the lifetime gift exemption of 1 Million Dollars and the yearly gift exclusion of up to $12,000 per beneficiary.  If the estate is extremely large this gets very complex and is outside the scope of this article, however it is possible to use a variety of other methods such as Grantor Retained Annuity Trusts in conjunction with the Irrevocable Life Insurance Trust very effectively even for estates at the highest levels.

Due to the nature of the trust beneficiaries must have a limited right to withdraw the gift for a short time after the grantor makes the gift.  Also the Irrevocable Life Insurance Trust can be used with both existing and new life insurance policies however existing life insurance policies present challenges that are not present with new policies specifically designed with the trust as the beneficiary.  An existing policy that is put into an Irrevocable Life Insurance Trust for the purposes of Estate Tax Mitigation is subject to a 3 year inclusion period.  This means that the Death Benefit will still be subject to the Estate Tax for the 3 year inclusion period.  Additional drawbacks to using a current policy in trust include the potential for the cash value of the policy being counted as a gift subject to the gift tax. 

If the insured is still in good health it may be better and cheaper to use the cash value in the previous Life Insurance Policy to fund a new replacement Life Insurance policy to be put into the Irrevocable Life Insurance Trust. 

Drew Kitchell is a published Financial Advisor specializing in high end Life Insurance Brokerage, Estate and Wealth Transfer Planning for affluent clients in and around the Aspen Colorado area and beyond.

He is also active in Charitable and outsourced Planned Giving both for a living as well as pro bono for the Aspen Rotary Club and The Rotary Foundation.

If you have Life Insurance or Planned Giving needs that are complex or sizeable Drew is the Advisor for the job, call him at 970-925-5900.