The irrevocable life insurance trust offers several advantages in estate planning.
William J. Davis, DDS, MS
Joseph J. Massad, DDS, and
Gary L. Rathbun, CLU, ChFC
In August, we talked about trusts from the definition point of view. This month, we will discuss why dentists should consider setting up a trust as part of their estate-planning process.
Why establish a trust? Dentists establish trusts for many reasons. The most common reasons include:
x- Incompetence or unwillingness of beneficiaries - Your beneficiaries may be unwilling to take the responsibility of investing or managing the assets you want to leave them. On the other hand, they may be willing to do it, but you may feel they are not qualified to handle the long-term responsibility of managing these assets. This same scenario also might come into play when making a gift to a minor, a handicapped person, or other special-needs beneficiary.
x- Fragmentation problems - Sometimes a dentist might want to leave his or her assets to several people, but the assets - such as a recreational cottage, a home, or a boat - cannot be divided. In such cases, you may want to make arrangements for several people to share in the use of the asset.
x- Creditor protection - Using a trust can add an extra layer of protection from claims by unscrupulous creditors. A trust also can add protection from the threat of asset depletion due to frivolous lawsuits.
x- Probate - Asset transfer by way of a trust to a beneficiary avoids the hassle, uncertainty, and costs associated with probate.
x- Privacy - The provisions of a trust are known only to the parties involved and not to the public. Also, only the trustee - and possibly the beneficiaries - have knowledge of the funding methods for the trust.
x- Personal protection - There may be a time when you no longer wish to, or are capable of, handling your own assets. A trust will protect you in the event of emotional, physical, or mental incapacity. The trust can have contingency language to take over when certain criteria are met, and preventing others from making decisions regarding your assets.
x- Contesting a will - Using a trust will greatly reduce the possibility of disgruntled heirs making claims against your estate. This would include spouses who wish to claim a state-mandated portion of your estate (generally one-third), regardless of what your will states.
x- Mixed appreciating assets - Most dentists want to treat their children and grandchildren equally. It is possible some of the assets in your estate will appreciate faster than others, and some assets may actually depreciate over time. Using a trust to hold these assets will spread the appreciation and depreciation equally among all the beneficiaries of the trust.
x- Long-term asset control - You may have certain wishes regarding the disposition of a particular asset. For example, you may want your dental practice or an asset that has been in your family for generations to stay in the family. A trust will keep people outside the family from gaining ownership.
x- Postpone ownership - The beneficiary may be a minor or for some reason unable to handle his or her own affairs. A trust will allow for postponed ownership for assets when beneficiaries are not in a position to take ownership of them or the income from the assets.
Trusts can allow you to meet your needs and be flexible when addressing many management, conservation, and disposition issues.
Creating a trust
When creating an irrevocable life insurance trust, several players are involved. Each player has a specific part to play. The first player is the grantor. The grantor is the person who establishes the trust and contributes money on an annual - or possibly a one-time basis - to pay for the trust.
The next person needed is the trustee. The trustee carries out the instructions put forth in the trust document. A trustee can be anyone you choose; however, we recommend you use a professional trustee, such as a bank or trust company. The trustee uses the money contributed to the trust by the grantor to purchase a life insurance policy, generally on the grantor and on his/her spouse.
The final players in an irrevocable life insurance trust are the beneficiaries of the trust. These are generally your children, but they can actually be anyone you choose.
Each year, for a preset period of 30 days, the beneficiaries must make an election to have the contribution made by the grantor used for the purchase of the life insurance on the grantor. This is known as the Crummey election. In a 1968 case, Clifford Crummey vs IRS established the Crummey election as part of the rules for irrevocable life insurance tTrusts. The beneficiaries have the option to elect to have your contribution paid to them in cash. However, most beneficiaries should not take advantage of this election, since it will greatly decrease their inheritance later ... and perhaps slightly annoy the grantor!
Here are some of the advantages to using an irrevocable life insurance trust in your estate plan:
(1)E The trust is irrevocable and not currently connected to the estate of the insured (the grantor). The proceeds will pass directly to the beneficiaries free of federal estate tax.
(2) The trust allows you to leverage up your annual gift. Each year, you and your spouse can gift $10,000 (1999 limit) to as many beneficiaries as you choose. These annual gifts can purchase a large amount of insurance for your heirs.
(3) The trust is used to pass on the benefits to the heirs. The proceeds will bypass probate and the delays and costs usually associated with the probate process.
(4) The trust allows you to control the disposition of your assets long after you are gone. The trustee can be instructed to pay income annually or to pay out principal at designated intervals throughout your beneficiary?s lifetime.
(5) Finally, the trust proceeds can assist the heirs by providing needed liquidity for the balance of your estate. Many costs are associated with settling an estate, so cash can be a much-needed commodity.
Trusts are a very useful tool in any dentist?s estate-planning process.
Remember, the trust can be an integral part of your overall plan; however, a trust is not the answer to all of your needs during the estate-planning process. You always should seek out competent professional counsel before implementing any estate-planning or trust strategy. Irrevocable means irrevocable. Make sure it is done right the first time!
Sheltering the breaks
Most of the time, dentists establish a trust for some reason other than just to save taxes. However, if structured properly, the right type of trust can save a tremendous amount of taxes.
Two of the most widely used trusts to save taxes are: 1) the A-B trust (also known as the credit shelter trust) and 2) the irrevocable life insurance trust.
A-B trust or credit shelter trusts - Under current federal estate-tax law, either spouse can leave an unlimited amount of assets to each other with no estate taxes. In doing so, however, a much larger amount of tax is due at the second death. The government allows everyone a unified credit amount, the amount of assets you can gift or leave someone else before the federal estate or gift tax applies.
By establishing an A-B or credit shelter trust, the spouse who is the first to die can use the unified credit. In 1999, this amount is $650,000. The first to die of a married couple can leave this amount to a trust, and the surviving spouse can receive income from the trust for life. The surviving spouse cannot change the beneficiaries of the trust or use the principal during his/her lifetime. At the death of the second person, all assets in the trust, plus any appreciation of those assets, will pass to the trust beneficiaries free of any federal-estate tax. This can save over $200,000 in taxes at the second death.
The irrevocable life insurance trust - This trust is exactly what the name implies. It is an irrevocable trust, which means the provisions cannot be changed once the trust is established. This type of trust is used to purchase and hold life insurance for the benefit of your heirs.
Under current law, it is very difficult for wealthy individuals to transfer significant amounts to their heirs over the unified credit amount. An irrevocable life insurance trust can be used to provide cash and security to the next generation at a minimal cost.