Proper planning key to life insurance

In the last column, I touched on just why we want to be very careful as to who is the owner of the life insurance policies that we use for estate planning purposes. As powerful a tool as life insurance can be, if not owned properly, the ultimate amount of benefit can be greatly reduced. It may also end up costing you a great deal more money in premiums than necessary as up to 40 percent of the proceeds can go to the government in the form of federal estate tax versus the desired 100 percent that should be available for your heirs.

Knowing this, it just makes good sense to get acquainted with a professional advisor in determining if life insurance is appropriate for your family, and if so, recommending and designing the proper plans. The next logical step is to be sure and have the policy(s) owned correctly. Doing so makes any possible negative consequences easily avoidable.

So just how should own these policies? Most times when there are large face amounts involved, it should not be you or your spouse. You could choose to have an adult child who is directly involved in your business, financial, and estate affairs own the policies. You could also choose to have a life insurance trust designed and drawn by competent counsel. Both can serve to achieve the desired effect of removing the value of the policy itself from being included in your taxable estate. Each method can and does serve families well. It just depends upon your circumstances as to which route will be your best bet.

For simplicity sake, having the policies owned by adult children or those with a vested interest in seeing that the policies perform their expected duties is a viable option. There are no legal fees or management duties involved and the whole thing is quite straightforward. You simply apply for your policy as the insured with your chosen owner correctly listed as both the owner and the payer of the policy. This owner must obviously have what is termed as “an insurable” interest, meaning there is a definable economic stake in the policy. This also makes the insurance contract legal and valid. The caveat is that there is no one other than the owner overseeing the management of the policy. Seeing that premium payments are made and that any cash value elements needed to guarantee the longevity of the policy are kept in place. This is where the vested interest comes into play. There can also be issues of the cash value in the event of a divorce.

A properly drawn life insurance trust can mitigate these issues. There is some legal work and fees involved but it is minimal in the scheme of things and often well worth the expense. We now have a trustee overseeing all aspects of the policy which helps to ensure that the policy performs as designed and the proceeds end up in the proper place. There are also further benefits in that through the use of what are termed crummey powers, we can use the life insurance trust as a target in which to gift premiums. Thus, we have a paper trail for the IRS that makes these gifts of a present interest and therefore usable for our current annual gift tax exemption of $14,000 per donor ($28,000 with both spouses) and per recipient.

Who and how the premiums are paid is of vital importance as the IRS considers incidents of ownership. Particularly in the case where a trust is not involved. Done wrong, the whole value can be brought back for estate tax purposes. Just another consideration for bringing in professional advisors to see all is done right.

Dennis Foster has been helping families with financial and estate planning needs for 25 years. He welcomes comments and questions and can be reached at 605-887-7069 or dennis@nvc.net.