Estates and estate plans have a mystique all of their own to the average observer. It is certainly a complex world of tax rules and regulations where inherited assets are taxed upon death. How might this affect you and the estate assets you now possess?
First of all what is an estate? Simply put it is the total of all of your assets including home, auto, pension and other retirement funds, collectibles and possibly the worth of a business minus liabilities constitutes your estate. Also included in the total estate is any life insurance owned by the estate owner.
When you purchase life insurance you own that asset and it becomes part of your estate. As an example, if you were to save $250,000 over your life and you wanted to leave it to your children that would be an asset. By owning a life insurance policy for $250,000 with your children as beneficiary you have created an instant asset; an instant estate. Same result.
Estate taxes came into play at the end of the 19th century as a means of redistributing wealth. As a result the estate tax system is now based on a tax on the recipients of the estate (children for example)due and payable within 9 months after the death of the second spouse in a typical family situation. The tax rate is anywhere from 18%-45%. A very large tax bill for anyone to pay.
There is a long list of entertainers, actors, singers and business people who did not have an estate plan in place at death. Joe Robbie was the owner of the football Miami Dolphins the year they went undefeated and won the SuperBowl. He was an attorney, sports enthusiast and savvy businessman. But when he died he left behind a huge estate with estate taxes due of over $47,000,000 and no estate plan. His heirs went through a nightmare of contentious family relations as a result and finally sold the football team at a bargain basement price......just to pay the tax.
In contrast, Jackie Onassis and Malcom Forbes through the intelligent use of trusts and life insurance left behind vast fortunes and little to no tax liability.
How does life insurance fit in? Once an estate is tallied up by the estate attorney and accountant, trusts are set up to remove assets from the estate (such as Charitable Remainder Trusts), a net taxable estate is arrived at and the projected tax rate and estate tax is calculated. For ex. an estate worth well over the annual estate tax exclusion of $2,000,000 is projected to pay $2.5 million in estate taxes.
The insurance underwriter produces what is called a survivorship life insurance plan or
"second to die " policy that insures 2 people on one plan. Underwriting is usually simpler on 2 lives as opposed to one so a less healthy spouse can get a better premium because of the healthier spouse.
The death benefit is written based on the projected amount of estate taxes payable, $2.5 million in this case and the named beneficiaries are the children; the ones who have 9 months to pay the estate tax.
An Irrevocable Life Insurance Trust (ILIT) is then created to protect the policy and remove it from the estate. Remember, ownership of a life insurance policy creates an immediate asset to the estate. The ILIT keeps the policy out the estate as an includible asset.
Upon the death of the first spouse no estate tax is due so no death benefit is paid. Upon the death of the second spouse, the estate tax is now due, the ILIT is dissolved and the proceeds of the $2.5 million life policy are released. The beneficiaries now have the liquidity to pay off the estate tax. They do not have to worry about selling off assets just to pay taxes, family relations are not changed because of taxes and the assets of the estate are conserved.
Can this happen to you? Possibly. Say you have a relative, say aunt Mary who has property of some kind. You have a home, a small business, retirement funds, collectibles such as art, jewelry, cars or stamps etc.. and you never considered yourself eligible for going over the $2 million estate tax exclusion because you thought to yourself, "Hey... I'm not rich!". Eventually, aunt Mary dies and leaves you with 100 acres of prime real estate in Maine and the current value of that property brings you well over the estate tax exclusion and now your children would have to pay an estate tax in 9 months if you died tomorrow. I've seen it happen.
Hopefully, this article has given you a snapshot of what estate planning can be. Using an estate tax team of an estate accountant, an attorney and a life insurance broker will further protect everything you worked so hard to set aside for your family.
Alan S. Fernandez is president of Foundation Financial Services with a BBA in Finance and Economics from Iona College, studied under the Life Underwriters Training Council and Certified Financial Planner programs and with 15 years in the insurance industry is a well known problem solver among businesses and individuals alike. He is also an insurance instructor with Citicorp. He can be contacted at afern109@optonline.net or visit the FFS website at http://www.foundationfinancialservicesny.com
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