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PART 3—TIME SCHEDULE/COURSE OUTLINE

		Suggested Time
	Introductions	5 minutes
I.	Two estate planning purposes of life insurance	10 minutes
II.	Life insurance products for estate planning purposes	30 minutes
III.	Transfer tax implications of life insurance	15 minutes
IV.	Federal estate taxation, part 1	20 minutes
	Break	10 minutes
	Subtotal	90 minutes
IV.	Federal estate taxation, part 2	15 minutes
V.	Federal generation-skipping transfer taxation	20 minutes
VI.	Federal gift taxation of life insurance	20 minutes
VII.	Outright gifts of policies	20 minutes
VIII.	Practical uses of life insurance in the estate planning trust	15 minutes
	Subtotal	90 minutes
	Total	180 minutes

COURSE OUTLINE

1. Two estate planning purposes of life insurance
   1. Estate enhancement
      • In many cases, a decedent’s estate will not be sufficient to provide for the basic needs of the heirs. This is particularly true for

        – Young clients
        – Clients with family members dependent on their income
        – Clients with small to moderate-size estates

      • It is essential for these clients to investigate their life insurance coverage needs and secure sufficient insurance to handle their dependent family members’ basic needs.
   2. Estate liquidity
      • Provides sufficient funds to cover

        – Probate expenses
        – Death taxes
        – Business continuation
        – Estate settlement

      • It is essential for these clients to investigate their life insurance coverage needs and secure sufficient insurance to handle their dependent family members’ basic needs.

2. Life insurance products
   1. Single life coverage
      • Term
      • Permanent

        – Fixed premium
        – Flexible premium
        – Variable premium

   2. Multiple life coverage
      • Survivorship life
      • Joint life

3. Transfer tax implications of life insurance

4. Federal estate taxation
   1. Life insurance payable to an estate
      • Life insurance should not be payable to an estate because:

        – Proceeds are subject to the claims of creditors.
        – Proceeds are subject to the costs of administration, such as executor’s fees.
        – Proceeds may be subject to state death taxes.

   2. Incidents of ownership
      • Include the power to

        – Change the beneficiary
        – Assign the policy
        – Borrow on the policy
        – Surrender the policy
        – Exercise contract rights or privileges

      • Incidents of ownership in a life insurance policy can force the proceeds to be included in the estate. Some previous examples triggering litigation incude

        – When the insured acted in a fiduciary capacity
        – When the insured retained a right to repurchase a policy – When corporate-owned life insurance proceeds are driven into the insured’s estate

   3. Transfers of policies within 3 years of death
      • The application of the 3-year rule to life insurance transfers is different from that for most transfers of other property. Other forms of property transferred within 3 years of death are generally excluded from the decedent’s gross estate. However, if a donor assigns an interest in a life insurance policy on his or her life and dies within 3 years of the assignment, the full amount of the proceeds will be included in the donor-decedent’s gross estate. This rule applies if any incident of ownership in the policy is transferred or released within 3 years of death.

   4. Life insurance and the federal estate tax marital deduction
      • Life insurance proceeds payable at the insured’s death to the insured’s surviving spouse can qualify for the federal estate tax marital deduction. Since the marital deduction is unlimited, the full value of life insurance proceeds payable in a qualifying manner to the surviving spouse will be deductible from the insured’s gross estate.

   5. Value of the policy includible in the gross estate
      • Policies on the life of the decedent

        – If a life insurance policy must be included in the decedent-insured’s gross estate for federal estate tax purposes, the amount that is included is the face amount of the policy. The face amount is the death benefit adjusted by (1) deducting any policy loan or other encumbrance and (2) adding any accrued or terminal dividends. Such concepts as cash value, total premiums paid, or reserves in the policy are irrelevant in this context and have nothing to do with the determination of what amount will be included in the decedent-insured’s gross estate.

      • Policies owned by a decedent on the lives of others

        – Under third-party ownership of life insurance, it is quite possible that a policyowner will die before the actual insured. When this happens, a life insurance policy is treated the same way as any other property the decedent owned. That is, the policy is included in the decedent’s gross estate at its fair market value at the time of the decedent’s death.

   6. Responsibility for payment of federal estate taxes by life insurance beneficiaries

5. Federal generation-skipping transfer taxation

   Life insurance is subject to the federal generation-skipping transfer tax (GSTT) in some circumstances. The GSTT is a particularly burdensome tax since it is applied (1) in addition to the federal estate or gift tax applicable to a transfer and (2) at the highest marginal transfer tax rate. Thus a transfer that is subject to the GSTT might face total transfer taxes in excess of 100 percent of the amount of the cash or property transferred. Fortunately, all individuals have a $1 million exemption against taxable generation-skipping transfers.

   Life insurance proceeds that are payable directly to, or may someday benefit, skip persons might be subject to the GSTT. A skip person is defined as any person more than one generation below the transferor.

   1. Direct-skip transfers
      • A direct-skip transfer involves a gift or bequest of property directly to a skip person, such as a gift from a grandparent to a grandchild. With life insurance, a direct-skip transfer could involve the payment of policy proceeds on a grandparent’s life to a grandchild as the named beneficiary. The GSTT could also be applied to a gift of the policy to a grandchild while the insured grandparent is still alive.

   2. Taxable distributions and terminations
      • The GSTT implications of life insurance trusts are more common and, in all probability, more difficult to avoid. Since all individuals have a $1 million exemption from the GSTT, only sizable estates are generally affected. It is critical to avoid inadvertent problems that may result in the GSTT when employing life insurance trusts that may benefit skip persons.
      • The GSTT applies to trusts in two circumstances—taxable distributions and taxable terminations. A taxable distribution occurs if a distribution of trust income or principal is made to a skip (with respect to the grantor of the trust) beneficiary.
      • A taxable termination occurs when either (1) a trust terminates and all remainder persons are skip persons or (2) all interests in the trust held by nonskip persons terminate.

6. Federal gift taxation

   Gifts of life insurance are treated in the same way as gifts of any other asset as far as the $10,000 annual exclusion or the split-gift provisions are concerned. Under the annual exclusion, $10,000 of gifted value per year per donee may be excluded from the gift tax base when life insurance is gifted. Under the split-gift provision, if a donor of a life insurance policy (or any other asset) is married at the time of the policy’s transfer, the amount of the annual exclusion will be doubled to $20,000 per year per donee if the nondonor spouse elects to split gifts.

   1. Policy valuation is as follows:
      • During the first year after purchase, the gift is equal in value to the gross premium paid to the insurer.
        
      • If the policy is paid up at the time of the transfer, the gift is equal to the amount of premium the issuing insurer would charge for the same type of policy.
        
      • If premiums are being paid at the time of the transfer, the gift is equal to the sum of (1) the interpolated terminal reserve and (2) the unearned premium on the date of the gift.

   2. Inadvertent Gifts

      Sometimes there is an inadvertent gift of policy proceeds. This can happen when a policy that is owned by one individual on another’s life matures by reason of the insured’s death, and a person other than the policyowner is named as beneficiary. For example, if a wife purchases a policy on her husband’s life and names her children as beneficiaries, the proceeds that could (and should) have been payable to her are payable instead to her children at her husband’s death. It is treated as if the policyowner (the wife) had received the proceeds and made a gift in that amount to her children. Gift splitting is not allowed, since there is no spouse with whom to split the gift.

7. Outright gifts of policies
   • A potential donor should consider one critical point before making gifts of life insurance policies: The gift must be real and not a sham. This means that something beyond a mere formal change in title is necessary.
   • One of the most common problems that occurs when a life insurance policy is assigned is the return of that policy to the insured by inheritance. If a husband transfers a policy to his wife to remove the proceeds from his estate and no precautions are taken, the policy is quite likely to return to him either by the wife’s will or through intestacy laws if her death occurs first. One possible solution is for the donee to specify in the ownership designation that the policy, upon the donee’s death, is to go to some family member other than the insured.

8. Practical uses for life insurance in the estate planning context

   There are many practical uses for life insurance in the estate planning context:

   • gifts of policies to trusts
   • grandparent-grandchild trusts
   • estate liquidity
   • equity of inheritance
   • nonworking spouse insurance
   • the second-to-die policy

   1. Gifts of policies to trusts
      • To a revocable trust
      • To an irrevocable trust

   2. Grandparent-grandchild trusts
      • One commonly used technique is for a grandparent to purchase insurance on the life of a child for the benefit of his or her grandchildren. When the grandchildren are minors, use of a trust rather than an outright gift is preferable. In a typical arrangement, the grandparent creates a funded irrevocable insurance trust with a trustee owning the policy on the child’s life. The trustee also pays premiums and designates the trust as beneficiary.

   3. Estate liquidity
      • Life insurance is the most effective way to supply needed dollars to meet federal estate tax obligations. First, the dollars, in the form of death proceeds, are free of federal income taxation. Second, if the life insurance is owned by someone (or something) other than the insured, the face amount of the policy will not be included as part of the decedent’s gross estate. Finally, the sizable death benefit may be purchased for pennies on the dollar in the form of premium payments.

   4. Equity of inheritance
      • There are many estate planning situations in which it is the estate owner’s wish to equalize inheritances among children. A prime example is when an estate owner has brought some of his or her children into a family business and intends to provide these children with an ownership interest in the enterprise. The plan may be to pass the interest to these children either during his or her lifetime or after death. However, if there are other children in the family who have no contact with the business, the estate owner may wish to provide for them in some other way so that there is equality among the children. Life insurance in this context is appropriate.

   5. Nonworking spouse insurance
      • There are many reasons why insuring a nonworking spouse makes good estate planning sense. If the nonworking spouse is no longer living, someone must be paid for services he or she previously rendered, such as cooking, cleaning, and laundering. Courts have often valued the cost to replace these services—domestic help and caring for the children—and the figure has run into several hundred thousand dollars. Acquiring life insurance to offset those costs and losses should be an essential part of family estate planning.

   6. The second-to-die policy
      • The unlimited marital deduction has created a need for greater planning for the death of the second spouse. That is why the second-to-die policy was instituted. Many life carriers offer a second-to-die policy that jointly insures a husband and wife. At the death of the first spouse, no death benefit is paid; at the death of the second spouse, the policy proceeds are paid to the named beneficiary.
      • Second-to-die coverage is often a perfect fit in a married couple’s estate plan. The most common use of second-to-die coverage is in an estate plan in which taking the unlimited marital deduction after the death of the first spouse will result in more substantial death taxes at the death of the second spouse. With second-to-die coverage, policy benefits will be paid when the insured married unit incurs these more substantial taxes—at the second death of the spouses.

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