Monday, August 8, 2011

The Yellow Dot Program for Medical-Alerts

With approximately 32 million drivers in the United States being age 65 or older, a new craze called the Yellow Dot program is gaining nationwide recognition.  The Yellow Dot began in Connecticut in 2002, and it's premise is quite simple.  Drivers affix a yellow dot sticker to the rear windshield of their vehicle, and this would alert emergency rescue workers that the driver has vital information such as a list of medical conditions and prescriptions, a photograph, or emergency contact information stored in their glove compartment.

Alabama's Yellow Dot program has recently generated a lot of interest.  Lora Weaver, program coordinator for the Northeast Alabama Traffic Safety Office, says that she has sent out over 150 information packets to interested people seeking to start programs in their own state or county. Proposals to keep costs down such as not requiring registration are highly favored, also.

This is a great program for all drivers, not just those over age 65. The more information that is available to emergency responders, the better they can care for accident victims of any age and notify the victims' families.

If you would like to see a Yellow Dot program implemented in your city or state, contact your local highway safety governing board for more information.

*Story adapted from "Drivers hot for medical-alert Yellow Dot kits" article found here.

Wednesday, July 6, 2011

We're in the Ahwatukee Foothills News!

On June 30, 2011 the Ahwatukee Foothills News ran a story featuring Kristel K. Patton P.C. and discussed the importance of estate planning.  We had a great time meeting with the reporter, and are thrilled that this information is reaching more and more people. Check it out HERE and share it with your friends!

Tuesday, July 5, 2011

July is National Recreation and Parks Month!

Did you know that 75 percent of Americans live within two miles of a public park or recreation facility, and that more than 75 percent of us visit them each year?  In recognition of the importance of parks and recreation facilities in our lives, and to foster the well-being of our environment and communities, the National Recreation and Park Association designated the month of July as Recreation and Parks Month in 1985.

As an estate planning law firm, we tend to focus on the financial security of our clients and their families.  Of course, we are also concerned with their physical and emotional well-being.  This is why we wholeheartedly support National Recreation and Parks Month and hope that it will serve as a reminder for our readers to take advantage of our nation's valuable resources.

Here are just a few of the benefits afforded by taking advantage of what America's parks and recreation facilities have to offer:

  • Improved physical and mental health.  Recreation and active living can help increase life expectancy by as much as two years and make for a more balanced, happier life
  • The development of specialized skills, a positive self-image and creativity in children and grandchildren
  • Increased ability to concentrate and learn
  • The opportunity to build stronger family relationships by spending quality time together, which in turn helps creating a lasting legacy for your family
  • And, perhaps most of all, the opportunity to get out and enjoy time spent with family and friends in a beautiful setting
If you would like to learn more about the parks and activities near you, visit  Then, take advantage of the next nice day, gather your family and friends together, and head out to the nearest park for a little recreating!

Tuesday, June 28, 2011

Natural Catastrophes and your Estate Plan

From the tornados that ripped through Alabama and Missouri just last month and the two catastrophic fires currently raging in south-eastern Arizona, Mother Nature has not been too kind lately.  And as hurricane season has officially begun, coastal cities hope they're not added to the casualty list.  Natural disasters like this serve as an apt metaphor and constant reminder of the importance of proper estate planning.

It is very hard to predict the exact time and severity of a natural disaster, so it is always important to be prepared.  Similarly, you just won't know when life's "tornado" will affect you and your loved ones, so taking the steps to create and execute an estate plan is also an important part in preparing for your future.

Many people have been lucky to survive these recent catastrophes, but still countless others have been injured and left disabled.  Disability planning is another crucial component in an effective estate plan.  Special needs trusts, health care directives, and powers of attorney are just a few of planning tools that most people overlook, to their peril, even if they do have an estate plan.

Also, because natural disasters--and any tragedies in life--are so unpredictable, it is imperative that you keep your plan up to date.  We recommend that you enroll in a formal maintenance program with your estate planning professional.  As an alternative, you should review your plan with an estate planning attorney once every two years, and after a significant life change has occurred such as divorce or a new child.

Be prepared for the unexpected by ensuring that you have a thorough, effective estate plan in place before you get caught out in the rain.

Tuesday, June 21, 2011

June is Gay and Lesbian Pride Month!

Since 2000, June has been declared Gay and Lesbian Pride Month.  This designation is based on the principle that lesbian, gay, bisexual and transgendered (LGBT) individuals should be able to live openly, without discrimination based on sexual orientation or gender identity.

At Kristel K. Patton, P.C., we believe that this is also a good time to consider estate planning needs that are unique to members of the LGBT community.  Certain legal documents, for example, should be drafted differently for LGBT individuals or couples (e.g., in states where a couple cannot be legally married.)  And still other documents take on added significance.

On this latter point, we advise all our LGBT clients to have us prepare advance healthcare directives, the legal documents needed in a hospital emergency to make sure one's healthcare wishes are honored.  We do this because we know that without these documents, our LGBT clients could be prevented from having the person of their choice as their medical decision-maker.

On a positive note, as mentioned in our previous blog post, there has been some recent legal progress on healthcare equality for LGBT folks:  As of last fall, hospitals are now required to permit all patients to have any visitor they choose, including a same-sex partner or other non-relative.  Nonetheless, if the patient can't speak for him or herself and hasn't put these wishes in writing, the door is still open for a family member to try to ban a same-sex partner and others from visiting at the very time when they are need most--at the patient's bedside.

At Kristel K. Patton, P.C., we also recognize that creating advance directives is not enough.  It's a known fact that most people do not carry these documents around with them.  And, it's also a known fact that they can be needed quickly, especially for an LGBT patient.  This is why we provide all our clients enrolled in our Empowered Legacy Planning process with membership in the DocuBank Healthcare Directives Registry, free of charge.  With this registry, a wallet card provides immediate access to our clients' healthcare directives 24/7/365, so that documentation can be produced and the wishes of each of our clients can be protected at a moment's notice.

It's also worth noting that the Human Rights Campaign (HRC) recently announced its new status as an LGBT Affiliate of DocuBank.  The largest LGBT civil rights organization in the nation, HRC has team up with this registry to help its members ensure that they can produce the legal proof of their wishes when it counts.

Thursday, June 16, 2011

Who Can Visit You in the Hospital? Anyone You Want!

We've all experienced it.  We wanted to visit a friend or relative in the hospital, but were told that visits were restricted to immediate family members.

No More!  Under new federal regulations, hospitals are now required to allow patients to have any visitors they want.

This new policy, which took effect in November 2010, recognizes that a patient should be able to choose whoever they'd like to be at their bedside.  Hospital care should be as "patient-centered" as possible, not guided by blanket rules designed to make life easier for hospital staff.  The policy recognizes that it's important for the patient to have the person who knows the patient's medical condition best to be present to talk with hospital staff, especially if the patient has difficulty recalling or communicating their own medical information.  In many cases, this person is not always a member of the patient's immediate family or "next of kin."

Of course, hospitals have the right--and the responsibility--to limit this visitor permission in certain circumstances, such as infection control, bad behavior of visitors, and other circumstances that would "jeopardize the care of the patient or other patients."  But these limitations are expected to be the rare exception rather than the rule.

So, while it's still probably not a good idea to invite the entire neighborhood to a party in your hospital room, you now have a great deal more control over which smiling faces you invite to come by and spend time with you.  And that can mean a lot!

Thursday, April 7, 2011

April 16, 2011 is National Health Care Decisions Day!

Most people are not aware of the importance of healthcare directives. Because it is often difficult to express your wishes regarding what would happen should you become severely disabled or die, these communications almost never happen, and loved ones are left without guidance if such a situation ever arises. 

In an effort to highlight the importance of advance healthcare decisions, the law office of Kristel K. Patton, P.C. is offering FREE HEALTHCARE DIRECTIVES FOR THE MONTH OF APRIL 2011.  (Services will include a Healthcare Power of Attorney and Living Will.)  

Everyone from the young to the young at heart are encouraged to take advantage of this opportunity.  The most precious gift you can give your family is advanced planning regarding major healthcare decisions.  This will ensure that they can focus on you during times of crisis, and not be burdened with heavy decision-making.  Peace of mind is priceless, but these directives are completely complimentary, with no obligation to use the firm for any additional services.  

For more information or to schedule an appointment, please call us at 480.855.8383.

Tuesday, March 15, 2011

Why Counseling? Why the Three Steps?*

Many people think of estate planning as a way to save estate taxes and perhaps a way to avoid probate.  There are many more important reasons for estate planning.

For example, have you considered the following questions?:

  • How do you want to be cared for when you can't take care of yourself?  
  • If your wife remarries after you die, do you want to make sure that her new husband can't spend your money? 
  •  If your husband hits a van full of lawyers after you die, do you want to make it harder for them to collect your money when they sue him?  
  • If your wife divorces her new husband after her remarriage, do you want to make sure that he doesn't get half of your money?  
  • Do you want to make sure that your guardians know how to share your values while they finish raising your children?

I suggest that most of people would answer "yes" to all these questions.  So how can you make sure your plan is accomplishing these things?

Problem #1 with Traditional Estate Planning:  Most estate plans are upside down!  They focus on tax planning instead of personal concern, protections, and goals.

Problem #2 with Traditional Estate Planning:  Most estate plans just don't work!  A plan works when every expectation of the client is met.  These expectations aren't met because clients and professional advisors see estate planning as a transaction ending in documents, instead of the process ending in results.  Things change.  Estate plans should, too.

We believe that client families will achieve the best estate planning results with a Three Step Strategy that uses clear, comprehensive, customized instructions for their own care and that of their loved ones.  The instructions might include a will, a trust, a power of attorney, a living will, and other documents.

Step #1: Work with a Counseling-Oriented Attorney as opposed to a word-processing attorney.  Most estate planning in the U.S. is little more than word-processing.  You don't need a professional for that! The professional's value come from the counsel and advice based on knowledge, wisdom, and experience.

Step #2:  Establish and Maintain a Formal Updating Program.  There is a constant change in personal situations, both family and financial.  Tax laws and other laws change every year in ways that will impact many estate plans.  Finally, because attorneys don't know everything, the attorney's experience and expertise change.  Without updating, plans won't work the way the family intended them to.  Without a Formal Updating Program, the updating rarely happens.

Step #3: Assure that My Wisdom is Transferred Along with My Wealth.  In many families, the parents have an abundance of wisdom that has often been earned the hard way.  Through Wealth Reception, an approach that prepares children and grandchildren (or nephews and nieces, or godchildren, or friends) to receive wealth, parents' wisdom can help make their money a benefit instead of the burden that is often becomes.

Most financial windfalls, including inheritances, disappear within 18 months.  Our clients can avoid that unfortunate conclusion to an otherwise worthy inheritance with proper Wealth Reception planning.

*Adapted from the Planning Partners Press.

Friday, March 11, 2011

Quality and Net Worth Are Not Synonymous*

Jack Kent Cooke started his business as a high school drop-out selling encyclopedias door-to-door, and grew until he owned a collection of media companies, sports teams, and real estate valued at $1.3 billion.  Most know him as former owner of the Washington Redskins football franchise.  Although a successful and sophisticated businessman, his estate planning failed miserably.

What Does This Have to Do With You? Though most of us don't have estates worth $1.3 billion, this is a great case study on how planning that is not well-designed and customized according to a client's wishes can result in devastating financial and emotional costs after their death.  This is not an issue of net worth.  It is a planning quality issue.

Jack Kent Cooke's Plan: Mr. Cooke has a will that was amended eight times.  It left seven executors, most of them former employees.  When presented with the will, most of them had never seen it before.

The Widow's Claim: Ms. Ramallo Cooke was Mr. Cooke's wife, whom he divorced once and then remarried.  Despite having signed a prenuptial agreement on her remarriage, a fight ensued, ending in a $10 million settlement to Ms. Cooke to end the expensive litigation ($6.8 million in legal bills.)

Sell Which Assets? An executor, Stuart Haney worked with Mr. Cooke to create the Jack Kent Cooke Foundation to help underprivileged students.  Due to a large estate tax bill, the only way the foundation could be funded was to sell assets of the estate.  Cooke's son (also an executor), has worked in management of the Redskins for most of his life, shared his father's passion for football, and dreamed of someday owning the Redskins.  Cooke, Jr. was adamant that the Redskins franchise not pass from family control.  However, because the sale of the team promised the best return, the executors, against the protests of Cooke, Jr., chose to auction the Redskins.  Cooke, Jr. was outbid an the team passed out of family control.

Paying the Executors: The will didn't specify how much the executors should be paid.  In Virginia, up to 5% of the estate is allowed.  Again, lawyers were hired, and litigation began.  Cooke, Jr. claimed that executors' fees exceeding $5 million were unreasonable.  The remaining executors felt that they earned and deserved the 5% fee ($37.6 million).  The case was decided in favor of the 5% fee.  Subsequently the count commissioner of accounts cut his fee to $415,000 to avoid further litigation.

In the End: Cooke, Jr. never received the Redskins, which he dreamed about and worked towards his entire life.  The executors were divided and bitter, and still have to work together as board members for the Foundation.  The estate settlement lasted 7 years and cost $64 million in professional fees.

Learning from Mistakes: Most clients believe that their situation is straightforward and simple and that they don't have a lot of money.  They may not have the wealth of Jack Kent Cooke, but proper planning is every bit as important for them as it was for him.  If they fail to plan well, or if their plan fails them, the result can be financial and emotional devastation for their families and loved ones after death.

*Adapted from the Planning Partners Press.

Tuesday, March 8, 2011

An Irrevocable Life Insurance Trust With All the Ingredients for Success*

As we've recently been discussing, Irrevocable Life Insurance Trusts (ILITs) are very powerful estate planning tools.  Unfortunately, they often fail  because people do not follow the particular rules necessary for them to succeed.  In addition, there are gift and estate tax consequences to be considered.  In this issue, we want to review with you a Private Letter Ruling (200404013) from the Internal Revenue Service about an ILIT that passed all tests with flying colors.

The Trust
The Basics: A husband created an Irrevocable Life Insurance Trust.  The husband funded the trust with shares of an S corporation, along with other assets.  The Trustees of the trust were his wife, along with a Corporate Co-Trustee.  The beneficiaries of the trust were the couple's children.  The distribution provided that upon the death of the husband, the trust would divide into separate trust shares for each child.

The Insurance: The trust then purchased a survivorship life insurance policy on the lives of the husband and wife.  The policy was purchased with the assets already inside the trust.  Ten annual premium payments were to be made, all with assets in the trust.  There would be no additional contributions to the trust by the husband or wife.

The Distribution: The sub-trusts created for each child, upon the death of the husband, would pay quarterly to each child the net income of their respective trust share.  The remainder assets will be kept in trust and distributed at the discretion of the trustee for care, health, education, maintenance, or support.

The Key Ingredients
The legal, financial, and tax advisors who participated in the creation of this trust really took the time to think through the variety of rules that impact this type of planning.  Some of the key strategies they implemented that allowed this trust to succeed are as follows:

1. The wife, as Co-Trustee of the ILIT, executed a written document denouncing her right as trustee to:
     a. Change the beneficiary of the policy
     b. Revoke any change of beneficiary
     c. Assign the policy
     d. Revoke any assignment of policy
This result was the avoidance of incurring incidents of ownership, which would have caused the amount of the life insurance to be included in the husband's estate.

2. The husband renounced any right to make contributions to the trust and to appoint a successor advisor.
This resulted in avoiding a gift tax problem.

3. The husband funded the trust, but had his wife consent to treat the gift as a split gift.
This resulted in doubling the amount allowed to be gifted without incurring gift tax liability.

4. Sufficient Generation-Skipping Tax exemption was allocated to the trust to result in zero inclusion ration for GST tax purposes.

The Payoff
This strategic approach allowed this ILIT to avoid any gift tax liabilities.  The proceeds of the policy were not included in either the husband's estate or the wife's estate.  The trust also has a zero inclusion ratio for GST tax purposes.  Most important, this trust accomplished the goals of the clients:
  1. To leave money to their children in a way that is protected from creditors and potential divorces;
  2. To leave money to their children in a leveraged manner; and
  3. To utilize strategies to reduce their estate tax liability.
This is a great example of how the strategic planning of advisors can help clients accomplish their goals!

*Adapted from the Planning Partners Press.

Friday, March 4, 2011

Irrevocable Life Insurance Trusts: Using ILIT Proceeds to Pay the Death Tax*

One of the more confusing aspects of an Irrevocable Life Insurance Trust (ILIT) is how the life insurance proceeds paid out to the ILIT can be used to pay the death taxes of the insured person.  The temptation is for the ILIT trustee (especially if the trustee is an inexperienced family member) to find out what the tax bill is, and then write a check to the IRS.  However, just as there are certain steps that must be followed in establishing an ILIT, there are also special considerations in receiving and paying out the life insurance proceeds after the insured has passed.

In a nutshell, the trustee of the Irrevocable Life Insurance Trust cannot pay the death taxes created by the insured person's estate  directly.  If the ILIT trustee does so, the payment is considered a taxable gift.  Instead, the death taxes should be paid by the living trust or probate estate of the deceased insured person.  Assuming the ILIT was set up and the insurance was purchased specifically to take care of this expense, how do we get the death proceeds from the ILIT to the living trust?

One method we employ is to include special language in the ILIT that allows the trustee to make loans to the maker's living trust or probate estate.  Let's say the life insurance proceeds are for $1,000,000 and the estate tax bill is $894,000.  The trustee of the ILIT can loan money to the trustee of the living trust.

If the loan method is used, the transaction must be at arm's length to avoid any gifting problem.  In addition, the indebtedness should be evidenced by a formal promissory note, and interest must be paid on the loan.  The loan must eventually be repaid or extinguished in some manner.  (We'll say more about that momentarily.)  So at the end of the transaction, the ILIT has a note receivable and the living trust has a note payable.

An alternative to making a loan is to have the Irrevocable Life Insurance Trust buy property from the maker's revocable living trust or probate estate.  Under current law, all of the property included in the maker's estate receives a step-up in basis at death.  Therefore, if the ILIT purchases property that has a step-up in basis for the purchase price equal to that stepped-up value, there will be no taxable gain.  If the price paid exceeds the value, then the difference will be subject to capital gains tax.

The net effect is that the living trust or estate has cash with which to pay the death taxes, and the ILIT now owns property.  Since the beneficiaries of the revocable living trust and the ILIT are almost always identical, there has been no real change in their economic positions.

Additionally, we typically included a merger clause in both the revocable living trust an the ILIT. This language allows the two trusts to collapse into one another and be administered as one trust -- as long as the terms of the two trusts are substantially identical.  In such a merger, the notes payable and receivable from the loan strategy would also cancel each other out.

*Adapted from the Planning Partners Press.

Tuesday, March 1, 2011

Irrevocable Life Insurance Trusts: Choosing Trustees*

Trustees for Irrevocable Life Insurance Trusts (ILITs) must be selected with special care because the consequences for not following the instructions in the trust can be serious.  The trustmaker is not permitted to act as a trustee of an ILIT.  Doing so would give the trustmaker too much control, and the value of the life insurance proceeds would be includable in his or her estate.  If the trust owns a second-to-die policy, neither trustmaker can be the trustee.

During the lifetime of the client, the family CPA may be the best choice.  Accountants are a good choice primarily because of their attention to detail.  An ILIT requires close attention for accounting, notification to beneficiaries, payment of premiums, and follow-up.  Since administration of an ILIT during the trustmaker's life is mostly ministerial, the accountant can be relied upon to meticulously follow the correct procedures.  After the death of the trustmaker, other trustees (including the client's children) can either replace the accountant or can be added.  At that point, we recommend appointing ILIT trustees consistent with those found in the trustmaker's Revocable Living Trust.

A bank trust department is another good candidate for the position of the initial ILIT trustee.  Like accountants, bank trust departments can be relied upon to carefully perform the business of administering the ILIT.  That is their primary business after all, and they typically use reliable and experienced professional trust officers.

Generally, if the ILIT holds only life insurance policies and a nominal amount of cash, the fee charged by most banks trust departments is reasonable for the tasks performed.  Recently however, bank fees have been escalating due to perceived liability, and many banks will only serve as trustee when there is a significant banking relationship.  On the other hand, accountants usually charge an hourly rate, and annual administration of an ILIT is often not terribly time-consuming.

Other advisors can make good trustees, too.  However, it is important that an advisor be detail-oriented and equipped to administer the ILIT properly.  Desire is not enough.  Attention to detail, good bookkeeping practices, good follow-up, and existing systems and procedures are absolute requirements for an advisor who takes on the job of ILIT trustee.  Attorneys and other advisors usually are not covered by malpractice insurance for work performed as a trustee and will usually turn it down.

If a trustmaker feels uncomfortable naming a bank or an accountant as sole trustee, or insists on naming a friend, a relative, or an inexperienced advisor, it is almost always better to add an accountant or a bank trust department as a co-trustee.  Two heads are better than one, and that is especially true in trusteeship.

The client may reserve the right to remove the trustee and (with certain limitations) to replace him if the arrangement later proves to be unsatisfactory.

*Adapted from the Planning Partners Press.

Friday, February 25, 2011

Shred Mania Month

We noticed on our little wall calendar today that February is "Shred Mania Month!"  It suggests that you go through all of your "important" papers, files, and documents.  Things that you thought were important six months ago, probably aren't anymore.  Once you've made sure that everything is up to date and accurate, "give that shredder a workout," it says.  How perfect!  Need help making sure your affairs are up to date?  That's where we can help you.  For our current clients, you can ensure that your estate plan will be in good working order by reviewing and sending back you Asset Review Reports.  Don't have an estate plan?  Well, now that you've cleaned out your files, bring all your papers in and we'll help you make one.  Happy Shred Mania Month!

Irrevocable Life Insurance Trusts: Annual Gifting & The "5 and 5" Limit*

Contributions to an irrevocable trust are considered gifts to the beneficiaries of the trust, and are therefore taxable.  Ideally, the trustmaker would use the $13,000 annual gift tax exclusion to help offset any gift taxes that may arise.  If there is more than one beneficiary of the trust, the maker could give up to $13,000 per beneficiary.  Under ordinary circumstances, however, the gift is not eligible for the $13,000 annual gift tax exclusion because the beneficiaries do not actually have the free use of the gift presently.  The amount of the gifts would instead reduce the maker's lifetime gift tax exemption amount (currently set at $5,000,000 in 2011), or if that is insufficient, they would then be subject to gift tax.

In order to qualify gifts to an Irrevocable Life Insurance Trust for the annual gift tax exclusion, the beneficiaries must have a "present interest" in the amount given to the trust.  A present interest can be created by giving the beneficiaries the right to withdraw the asset from the trust under a provision known as a withdrawal right, sometimes called a Crummey power.

In a famous court cases in the late 1960s (Crummey v. Commissioner), the courts decided that if an irrevocable trust's beneficiary is given the right to withdraw a gift made to the trust for a reasonable period of time after the gift is made, the gift will qualify for the annual exclusion.  The number of annual exclusions that are allowed for a gift to an ILIT is equal to the number of beneficiaries who have a demand right.  For example, a demand right can be given to children and grandchildren.  If there are two trustmakers, then $26,000 per beneficiary can be given to the ILIT and still qualify for the annual exclusion.

The right to withdraw assets means that the demand right beneficiary has a power of appointment during the time in which he or she can withdraw the assets.  The Internal Revenue Code stipulates that the release or lapse of the power of appointment results in a gift of a "future interest to the other beneficiaries."

This means that if a beneficiary does not exercise his or her right to withdraw, that beneficiary is making gifts to the other beneficiaries of the amount that was given up. If this amount exceeds (the greater of) $5,000 or 5% of the total assets in the trust, then the beneficiary is considered to have made a gift of a future interest to the other beneficiaries.  The is called a gift over amount.

The amount of this gift reduces the beneficiary's own exemption equivalent amount.  As a result, though many clients desire to use the full $13,000 annual gift tax exclusion limit, they find it creates tax problems for their beneficiaries.

One solution is to have each beneficiary allow his or her right to lapse with respect to the "5 and 5" amount, but retain an ongoing power to withdraw the excess amounts which have been contributed to the trust.  These are called "hanging powers."

Another solution is to create a separate share for each beneficiary.  Using this strategy, when the beneficiary allows his demand right to lapse, the lapsed amount is allocated to a separate share which that beneficiary ultimately receives.  no other person benefited and, therefore, there is no gift over problem.

*Adapted from the Planning Partners Press.

Tuesday, February 22, 2011

Irrevocable Life Insurance Trusts: Individual vs. Joint Trusts

An irrevocable life insurance trust with one trustmaker is called and individual trust.  An irrevocable life insurance trust with two or more trustmakers in called a joint trust.

Individual Trusts

Individual trusts are used by unmarried trustmakers who want to avoid federal estate tax on their insurance proceeds.  Because unmarried trustmakers do not have the benefit of the marital deduction, irrevocable life insurance trusts are extremely important if their estate exceeds $5,000,000 in 2011.

Individual irrevocable life insurance trusts are also used by married trustmakers who want to take care of spouses and family members while ensuring that life insurance proceeds escape taxation in their own estates, as well as in their spouse's and family member's estates.

In some cases, two individual irrevocable life insurance trusts are created -- one for the husband and another for the wife.  Each irrevocable life insurance trust owns and is the beneficiary of policies on the life of its trustmaker.  No matter which trustmaker dies first, the proceeds can then be used to care for the surviving spouse, children, and other beneficiaries.  When the second spouse dies, the proceeds will be available to pay federal estate tax and/or meet other planning goals.  Both policies' proceeds will be free from federal estate taxation.

Individual irrevocable life insurance trusts are also used when the trustmaker has existing life insurance policies that he or she would like to transfer to an irrevocable life insurance trust.  Prudent planning often dictates the use of new life policies when an irrevocable life insurance trust is being created.  However, new policies aren't always feasible.  For example, a trustmaker that experiences health problems may find that the premiums required for a new policy are simply too expensive, or even that they are no longer insurable.

Joint Trusts

A joint irrevocable life insurance trust generally owns a second-to-die policy on the lives of both spouses.  This policy pays when the second spouse dies, so it is ideal for when the purpose of the life insurance is primarily to pay estate taxes.

A benefit of this type of policy is that the premium payments are generally lower than they are for two individual policies because premiums are based on the joint actuarial lives of both insured person.  A second benefit is that the proceeds will be available to pay federal estate tax regardless of which spouse dies first.

Individual and family circumstances determine whether an individual irrevocable life insurance trust or a joint irrevocable life insurance trust is better.  A major decision factor will be whether the client wants to use the insurance to benefit a spouse or children, or to pay estate taxes.

*Adapted from the Planning Partners Press.

Friday, February 18, 2011

Irrevocable Life Insurance Trusts: What To Do With Existing Policies*

Previously, we explored the steps that are taken when funding an Irrevocable Life Insurance Trust (ILIT) with a brand new insurance policy.  But what if a client trustmaker is no longer insurable or premiums would simply be too expensive?  Can we use policies that the client already owns?  The answer is "yes," but with caution.

The proceeds from an insurance policy are includable in the estate of a decedent if the decedent possessed "incidents of ownership" either at death or within three years of death.  This means that if a trustmaker transfers a life insurance policy that he or she currently owns by gift to an Irrevocable Life Insurance Trust, and if the maker dies within three years, the life insurance proceeds will be subject to estate tax.  This is the primary reason that new policies should be purchased by the trustee of the ILIT when possible.  It eliminates the three-year look-back for inclusion.

Another potential problem arises when using existing life insurance to fund an irrevocable life insurance trust.  Many times, the life insurance has a substantial cash value.  If it does, then the value of the policy is treated as a gift to the irrevocable life insurance trust.  If the value exceeds $13,000 multiplied by the number of demand right beneficiaries, then the excess will reduce the $5,000,000 (2011) exemption equivalent.  If the exemption equivalent has been used, then a gift tax will be due.

If the existing life insurance policies are sold to the life insurance trust, this three-year rule is avoided.  Of course, for the irrevocable life insurance trust to be able to purchase the policies, enough cash will be need to be given to the irrevocable life insurance trust to pay for the policies.

When life insurance policies are sold, we must consider whether or not the sale will be a "transfer for value" which will result in the death benefit being income taxable.  To avoid this result, the sale must fall into one of the exceptions to the transfer for value rule.  The most frequent solution to this problem is to sell the policy to a partner of the insured.  By giving interests in a family limited partnership, for example, to the irrevocable life insurance trust, the irrevocable life insurance trust becomes a partner of the insured person.

Care must be taken to insure that the policy is being sold for fair market value.  In most cases, the policy value information provided by the insurance company will suffice.  However, if the insured person is in poor health, an outside appraisal of the policy may be needed.

If a trustmaker insists on using an existing policy, and none of these solutions are available, an existing life insurance policy can still be placed into an ILIT.  However, the trustmaker must be aware of the rule and understand that the strategy won't be fully effective until three years have passed.  Or, if insurable, the trustmaker might consider the purchase of a three-year term policy in case of death during the waiting period.

*Adapted from the Planning Partners Press.

Tuesday, February 15, 2011

Irrevocable Life Insurance Trusts: Handle With Care*

Although Irrevocable Life Insurance Trusts (ILITs) are a wonderful planning tool, they must be implemented carefully to avoid serious problems.  Here is a quick summary of the process that should be followed when a client contemplates purchasing a brand new life insurance policy:
  • The need for life insurance is established by analyzing the liquidity and estate planning goals of the family.
  • The family's life insurance expert gathers preliminary medical information and schedules physicals in order to determine insurability.
  • After determining insurability, the irrevocable life insurance trust is prepared. The trustmaker (or trustmakers if a joint irrevocable life insurance trust is to be created by a husband and wife) signs the irrevocable life insurance trust.
  • The trustee applies for a taxpayer identification number for the trust and opens a bank account in the name of the trust.
  • The trustmaker makes a gift to the irrevocable life insurance trust that the trustee deposits in the trust's bank account.
  • The trustee notifies the beneficiaries of their limited right to withdraw their share of the gift from the irrevocable life insurance trust.  (Often referred to as Crummey Notices based on the name of a plaintiff in a court case against the IRS.)
  • The beneficiaries sign an acknowledgment that they have received the notice and return it to the trustee for the trust's records.
  • The beneficiaries allow their withdrawal rights to lapse (as opposed to waiving the rights).
  • The trustee signs applications for the life insurance.
  • The trustee pays the life insurance premium and the policy is issued showing the trust as the owner and the beneficiary.
Irrevocable trust are used extensively in sophisticated estate planning because they remove assets from an individual's estate and allow a certain degree of control by their makers.  When they are properly designed and implemented, they also allow a surprisingly high degree of flexibility.

However, professional advisors must exercise caution to avoid shortcuts that might cause the strategy to fail.  If the withdrawal notices are not issued, for example, the trustmaker has made a gift of a future interest which doesn't qualify for the annual gift tax exclusion.  Or if the insured is listed as the policy owner on the insurance app (instead of the ILIT being listed as owner), the IRS can find "incidents of ownership" that will cause the insurance proceeds to be included in the taxable estate -- in spite of all the precautions taken to prevent that.

Each step of the process is there for a reason, and must be carefully and patiently followed.

*Adapted from the Planning Partners Press.

Friday, February 11, 2011

Irrevocable Life Insurance Trusts: The Benefits*

In our last issue, we mentioned that if life insurance is not owned correctly or if premiums are not paid in the most tax-efficient manner, gift and estate taxes can potentially reduce the benefits of life insurance policies by more than half.

An irrevocable life insurance trust (generally referred to as an "ILIT"), potentially protects the value of life insurance policies in several ways:
  • No Gift Taxes. Allows premium payments to qualify for the $13,000 annual gift tax exclusion.
  • No Estate Taxes. It avoids a federal estate tax of up to 35% (2011) on life insurance proceeds on the death of the insured person(s). (The actual percentage will depend on what year the insured dies.)
  • No Generation-Skipping Transfer Taxes. With proper planning, it can shelter those proceeds from estate taxes for many generations while also avoiding the generation-skipping transfer tax when its assets pass from generation to generation.
  • Continued Control. By including explicit instructions to the trustees regarding future beneficiaries, it permits a trustmaker to make gifts with strings attached.
  • Protection from Creditors and Predators. Assets of the irrevocable life insurance trust will not be subject to the claims of your creditors or your beneficiaries' creditors, as long as the assets remain in the trust.
  • Insure Liquidity to Pay Debts and Estate Taxes. By permitting the trustees of the ILIT to purchase assets from the taxable estate or to loan trust principal to the estate.
  • Minimize Federal Gift & Estate Taxes. The principal of the irrevocable life insurance trust, including insurance proceeds added to it upon death, will be free of federal gift and estate taxes.
  • Minimize Income Taxes. Life insurance proceeds will be paid to the irrevocable life insurance trust free of income taxes.
  • Avoid Generation-Skipping Transfer Taxes. If the client and the representatives of the estate make proper elections on gift and estate tax returns, all assets of the irrevocable life insurance trusts will be able to pass from generation to generation, free of both estate and generation-skipping transfer taxes.  This will enable the client's family to build wealth in the trust, free of all forms of transfer taxes, for generations.
ILITS obviously have many benefits.  However, in our next issue, we'll discuss planning pitfalls to avoid when working with irrevocable life insurance trusts.

*Adapted from the Planning Partners Press.

Tuesday, February 8, 2011

Irrevocable Life Insurance Trusts*

An Introduction

This introduction is the first of a multi-part series on an extremely important planning tool -- the Irrevocable Life Insurance Trust (often referred to as an ILIT).  The ILIT is not as simple as it appears at first glance.  It has the potential to blow up if it isn't 1) based on sound counseling, 2) drafted well, and 3) implemented with precision.

In future issues, we'll discuss the procedures that must be followed every time an ILIT is used, what to do with existing policies, the differences between individual and joint ILITs, how ILITs impact annual gifting programs, the famous "5 and 5" limit, the risks when estate taxes are paid from the proceeds of an ILIT, generation skipping, and choosing proper trustees.

The Big Picture

Life insurance is a critical tool in estate planning.  Life insurance proceeds create liquidity at precisely the time it is needed to pay the expenses of a person's final illness and death -- and to pay estate taxes if necessary.

In addition, life insurance provides cash for beneficiaries of estates that are asset-rich, but cash-poor.  A family business owner may use it for beneficiaries who are not involved in the business.  In a second marriage, one spouse may use it to provide for the other, while preserving the bulk of the estate for children.

Life insurance payable to a designated beneficiary avoids probate (unless the estate of the insured person is erroneously named as the beneficiary). If life insurance is not owned correctly, however, or if premiums are not paid in the most tax-efficient manner, gift and estate taxes can reduce the benefits of life insurance policies by approximately half!

Many people believe that life insurance is exempt from all taxes.  This is not true.  They may remember an advisor telling them that they "won't pay taxes" on the life insurance proceeds.  The advisor, of course, had federal income tax in mind.  Income taxation is separate and distinct from estate taxation.  And if you own life insurance, the death proceeds will be subject to federal estate taxation and perhaps state estate taxation, depending on the state in which you live.

As long as the insured person has any rights or powers over the policy (referred to as "incidents of ownership" in the Internal Revenue Code), the proceeds will be included in his or her estate for estate tax purposes.

To avoid this problem, a life insurance policy can be purchased by, or contributed to, an irrevocable trust.  The insured person cannot be a trustee or beneficiary of that trust because both control by a trustee and enjoyment of benefits as a beneficiary would constitute incidents of ownership.  Instead the irrevocable trust (an ILIT) becomes both the owner and the beneficiary of the policy, and the insured person chooses trustees to manage it.

We often think of life insurance in the context of paying estate taxes.  However, even those estates that will never be large enough to be taxable will probably include insurance policies purchased for other reasons.  By having those policies owned in an ILIT, the estate has more room for growth.

More next issue...

*Adapted from the Planning Partners Press.

Tuesday, January 25, 2011

Will a Trust Really Fail for Lack of Funding?*

In some jurisdictions, lack of any trust corpus (even just a couple of dollars, or some personal property) will cause the trust to be treated as if it were never created to begin with, and attempts to place assets into such a trust in the future cannot salvage or resurrect the defunct trust.  Most trusts that are created have some modicum of a trust corpus to prevent such a disaster.  Therefore, having anything in the trust will prevent it from failing, right???  That depends on your definition of "fail."  In order to answer the question, we must first talk about how funding works in relationship to a trust.

How does a trust work?  Think of a trust as a bucket, or a treasure chest.  One writes instructions on the outside of the bucket about what one wants done with the things that are in the bucket.  The trustmaker then takes the "bucket" and puts it into the hands of someone the trustmaker can rely on--that's the trustee.  The trustee's job is to follow the trustmaker's instructions with regard to the things that are in the bucket.

What will happen if the bucket is empty when the trustee attempts to follow the trustmaker's instructions after the trustmaker has died?  The trustee only has authority over what is in the trust, so if there is nothing in the trust, then there is nothing for the trustee to do.  (And as mentioned previously, if there is really nothing in the trust, then it may be void, depending on the controlling state law.)

Anything left outside the trust is outside of the trustee's control.  That means that the trustmaker's directions will not be followed with regard to those assets that are out of the trust.  Some assets may find their way back into the trust through a pour-over will, but typically this requires the expense, delay and publicity of probate to do so.

The process we call "funding" is the process of titling assets so that they are in the trust "bucket"--controlled by the trustee.  These assets will be controlled by the trustmaker's directions without the need for probate.

So, back to our question:  having anything in the trust will prevent it from failing, right?  If the measure of success is mere legal sufficiency, then that is correct.  However, the true measure of a trust's success is not whether it is "legally sufficient," but whether the trust meets the client's goals.

One common motivation many have for seeking out an attorney to create a trust is so that their family will be able to avoid the cost, delay, and publicity of probate on their death.  Failure to fully and properly fund a trust means that the client's directions will not be followed with regard to those assets not in the trust, or at least that probate will not be avoided.

If a trust fails to do what the client wanted (transfer assets by specific instructions contained in the trust, or avoid probate, for example), then it has failed whether the trust is legally sufficient or not.

Hopefully, when you buys a gallon of milk at the grocery store, it comes in a container.  But what if you pay for a gallon of milk and only get an empty or half-full container?  You would be upset, and rightly so.  However, people buy empty (or, at least, not full) trust buckets frequently, and do not realize the reduced value they are receiving.

Make sure you are getting full value for your estate plan by working with an attorney who will ensure that the trust bucket is full when created, and has a formal process in place to make sure that it stays that way.

*Adapted from the Planning Partners Press.