Life Insurance Trusts

Many families have life insurance policies on the parents, especially while the children are minors. The idea is to provide financial support for minor children and to provide liquidity in an otherwise illiquid estate. But if your estate has any sort of assets, your estate may run into tax problems - you'll owe money to the IRS. This can sometimes be avoided or minimized with a life insurance trust.

A life insurance trust is a separate entity apart from the insured so the policy is not included in the insured's estate. But there are many rules to follow when setting up a life insurance trust to make sure that it is properly segregated from the insured's estate.

First off, the life insurance must be an irrevocable trust. This means that once you make the trust, you cannot change the terms of the trust. This also means that you, as the insured, will not be able to change the beneficiaries of the life insurance policy.

Second, you must name a trustee that will manage the trust. You cannot be the trustee, and if you are named as the trustee, the insurance policy will be included in your estate (the objective being to keep the policy out of your estate). Often times, you will see the family accountant or attorney named as the initial trustee.

Next, the irrevocable life insurance trust must own the life insurance policy. This can be achieved in basically two ways: the trust may purchase the policy or the insured may gift a pre-existing policy to the trust. If a gift is made, then the insured must live at least three years or the policy will still be included in the insured's estate. If the trust purchases the policy, it must obtain the cash in order to do so. In the typical trust, the premiums are obtained from the insured via gift.

This leaves a substantial problem - the gift of a future interest. The gift would still be included in the insured's estate. The solution: Crummey letters, named after the case that first presented this solution. In the typical Crummey letter solution, the Grantor/insured makes a gift to the trust, then the trustee sends a letter to the beneficiaries stating that they have the ability to withdraw the gift for a certain period of time. Once that period expires, the trustee then uses the cash to pay the annual premiums. By giving the beneficiaries a right to withdraw the gifts to the trust, the premiums become a present interest and thus excludable from the insured's estate.

Once the insured passes on, the policy is paid to the trust. The trust is then distributed to the beneficiaries (typically the insured's children) according to the terms of the trust set up at the beginning.

Irrevocable Life Insurance Trusts ("ILIT" for short) are good vehicles to provide liquidity to estates, but still be able to avoid estate tax consequences if done properly.

Important Numbers for 2008

The highest estate tax rate remains at 45% and the exemption amount (the tax free part) also remains at $2 million. Meanwhile, in an effort to reduce your estate, you may give $12,000 under the annual exclusion.

For retirement plans, you can defer up to $15,500 through a 401(k) and $10,500 through a SIMPLE plan. Meanwhile, the IRA contribution limits increase to $5,000. All three retirement plans have higher limits if you above 50 ($20,500 for 401(k), $13,000 for SIMPLE, and $6,000 for IRA). Remember that you must have earned income to be eligible for those plans.

Speaking of earned income, the Social Security taxable wage limit has increased to $102,000. It'll be a little later in the year, if ever, before you see those taxes disappear from your check. If you are under the age of 65 and retired (lucky you!), you can earn up to $13,560 without losing your benefits.

Meanwhile, the kiddie tax is coming after your little ones that don't actually work for their income. The threshold increases to $1,800 for children up to the age of 19 unless they are full-time students, in which case the age limit is 24 years old.

But if you have a nanny or household help, you have to withhold taxes on wages over $1,600.

Let Your Family Know About Your Accounts

Even if you do not have a will, a trust, or any other parts of a complete estate plan, at least do one thing for your family before you die: Make a list of all your accounts with the following information:

• Institution where the account is located
  
• Account Number
  
• PIN Number or Password
  
• The name and phone number of the broker or account representative, if any
  
• Estimated balances

The accounts you should be on this list include but are not limited to:

• Checking and Savings Accounts at your primary bank
  
• Checking and Savings Accounts at any secondary bank (think online Savings Accounts)
  
• Retirement Accounts
  
• Credit Cards
  
• Mortgages
  
• Safe Deposit Boxes
  
• Insurance Policies

Also include information on how the bills are received (US Mail, Email, Website, etc) and paid (automatic draft, check, credit card, etc). Please do not leave your children in the dark because they do not know how to get the bill and how to pay for it. It is also helpful to leave your email addresses and passwords on this same list - often times you get notices or copies of bills at your email address that you may not receive in the mail.

Include on this list the name of any accountants or CPAs that may handle your tax matters, any attorney that you have worked with (especially if you have done any estate planning work with them), doctors, bankers, or other people that would have important information that your family would need to know.

After you have completed this list, let someone know where it is. If you want, you can seal it in an envelope to prevent disclosure of the information (you'll know when it has been tampered with). Do not leave it in your safe deposit box, however. If you are deceased, the bank will most likely seal the box until a court orders it opened.

If you fail to provide anyone with this information, your family will have to go through all your records to find this information. Some of it may be lost forever (if they don't know about that insurance policy, how can your family collect on it?) Your family will appreciate the fact that you were responsible and took the time to gather this information for them. Remember, you know best where your accounts are.

Updates to Your Estate Plan

Several readers have asked how often they should update their estate plan, including their wills, advanced directives (living wills) and power of attorneys. My general recommendation is a cursory review every year and a detailed review every five years or any time that there is a major event. Major events include:

• Marriage
  
• Divorce
  
• Birth or Adoption of a Child
  
• When a child reaches 18 years old
  
• When you receive a significant inheritance
  
• When you have a significant change in assets
  
• Change in health status

Most Adults Don't Have A Will

Over half the American population does not have a valid will according to a recent article by Alan Kopit at Lawyers.com. Only one in three African Americans and one in four Hispanic Americans have a will. However, the number of Americans that have a living will or medical directive has increased in recent years, after controversies such as Terri Schiavo. One in ten of those that don't have such documents (wills or living wills) say they do not have any kind of estate plan because they do not want to think about dying or becoming incapacitated.

If you do not have an estate plan in place, the State is left to determine how it thinks you would want your assets distributed or medical decisions made. That means that your assets will be distributed to your family and you will probably be left on life support for years. If you are left on life support even without a hope for recovery, you may be draining important resources away from your family. And what happens to your kids? Your pets?

It is tough to face the possibility of one's own death. But that does not stop it from coming, sooner or later (preferably, later). The piece of mind that your loved ones will be taken care of should be enough to kick start you into getting a proper will. And if you do not want to be left on life support forever, make sure your wishes are known. If you are worried about costs, go back to the old adage, an ounce of prevention is better than a pound of cure. With a short trip to an attorney's office and a few hundred dollars for a living will, Terri Schiavo could have avoided the lengthy court battle that the two sides of her warring family endured.

It will be the best present you can give your family.

Second Marriages and Estate Planning

In a recently published article from SmartMoney, heirs worry when their parents re-marry. Why? Their inheritances are at-risk, of course. This is just a reminder that pre-nuptials are not only for the young, wealthy, and working. Pre-nuptial agreements are a necessity any time you are getting married, and a complete estate plan is a necessity any time you have a major change in your life. Those major changes include, but are not limited to:

1. First marriages
   
2. First divorces
   
3. Having or adopting a child
   
4. Major accumulation of wealth (example: inheritance from your parents or winning the lottery)
   
5. Subsequent marriages and divorces

In Georgia, there have been some recent changes to the way pre-nuptial agreements are enforced. Before you sign one, make sure to talk with an attorney about your agreement.

Although mentioned in the above article, it is worth repeating: be aware that there are specific rules regarding house certain types of assets are transferred through the probate process. This includes 401(k)s and titled assets such as homes. Before you change the status quo, talk with an attorney that is familiar with the probate rules regarding the specific assets.