Irrevocable Trusts: Pay The Trustee

A long time ago, in a galaxy far, far away I remember reading an IRS Private Letter Ruling that had about it the worst method an insured/grantor could use to pay premiums on a policy inside an irrevocable trust.

He was the sole owner of a business that each year cut a check directly to the carrier for the total amount due.  The taxpayer was asking for a determination as to whether this quick-and-easy A-to-B transaction for maintaining a policy outside of his taxable estate would be deemed an incident-of-ownership resulting in the inclusion of the benefit in his taxable estate at death.

I’ve searched half-heartedly and unsuccessfully for the ruling.  But if memory serves me well, which it well may not, the Service did some “deeming”, but not in the unfavorable direction of finding an incident-of-ownership anywhere in the works.

It treated the taxpayer’s monetary circumlocution as: first, deemed income to the taxpayer from the company that must be reported as income; second, a deemed gift from the taxpayer to the trust that must be reported as such; then third, a deemed premium payment by the trustee to the carrier – all without giving rise to any incident-of-ownership in the grantor/insured.  Well, how about that?

It’s tempting to jump on such reasoning when it becomes bothersome to set up a trust checking account, or go through the multi-step process of actually gifting money to the trust and hoping that the godparent of the beneficiaries (who graciously offered to serve as trustee) doesn’t forget to pay premiums in the years following his or her retirement to the beach.  But there are some serious concerns created by the convoluted route taken by the premium in the illusive PLR mentioned.

If avoiding gift taxation is dependent on use of available annual exclusions then two things are necessary to qualify for protection.  The beneficiaries must receive notice of their right to withdraw contributions made on their behalf, usually accomplished through timely “Crummey letters”.  More important, the trustee should be in a position to actually fulfill requests from beneficiaries should they choose to exercise their Crummey withdrawal privilege.

If the only asset in the trust is the policy and the cash for premiums that constitute the annual gift merely flies over the trust each year, the Service is in a strong position to argue that the present interest necessary to qualify for the exclusion is only an illusion.

In addition, a properly drafted irrevocable trust implemented to keep death benefits free of estate taxation will only allow and not require a trustee to purchase life insurance on the grantor’s life.  This avoids any argument of grantor control over the policy.  However, if each year, premiums are paid directly to the carrier the grantor has, in effect, forced the trustee to purchase coverage.  So, how do you spell a-u-d-i-t?

Too often shortcuts are taken in the establishment of irrevocable trusts and too often insufficient attention is given to their ongoing administration.  While it is not the legal responsibility of the insurance advisor to see that all is done according to Hoyle, it should be his or her annual practice to make sure that the proper parties are fulfilling theirs.

Contact your Advanced Markets Team with questions you have concerning your casework that involves trust planning or estate and gift tax concerns.

A New Era For Your IRA!

There’s the joke about the insurance advisor who said to her client:  “I have some bad news and some good news!  The bad news is your premiums will be higher than we thought!”  Client:  “Gee, what’s the good news?”  Advisor:  “It’s because you’re highly rated, so you won’t have to pay them for nearly as long!”

A little research reveals that the good news-bad news opening in conversations has been around for over a hundred years, and that it became popular as a standard predicate for jokes during the 1960s.  So it’s a good to see that it has worked its way around into the life insurance marketplace!

Part of the government spending bill passed in December is legislation know as the SECURE Act, which stands for Setting Every Community Up for Retirement Enhancement.

SECURE contains provisions that affect qualified retirement plans in general; but consider the good news and the bad news regarding the changes the new law makes concerning IRAs.

The Good News:

72 is the new 70-1/2!  Under prior law required minimum distributions (RMDs) had to begin by April 1 of the year after a taxpayer reached age 70-1/2 or severe penalties applied.  Now, anyone who reached age 70-1/2 after December 31, 2019, does not have to take RMDs until April 1 in the year after they reach age 72.

Twilight contributions!  Previously taxpayers could not make contributions for the year they turned 70-1/2 and beyond.  SECURE allows them to make contributions any year if they have earned income at least in the amount of the contribution.

Children are Cheaper!  Several exceptions exist that allow for un-penalized withdrawals prior to age 59-1/2.  Another has been added permitting parents to withdraw up to $5,000 to cover costs of qualified birth and adoption expenses up to one year after the event.

The Bad News:

Taking the life out of “stretch”!  A common planning strategy under prior law was to properly designate beneficiaries on an IRA anticipating that they could stretch receipt of the benefits over their life expectancy.  SECURE mandates that most designated beneficiaries must now make full distribution by the end of the 10th calendar year following the taxpayer’s death.  Exceptions to the limitation are available to surviving spouses, disabled or chronically ill persons, minor children of the taxpayer, or those less than 10 years younger than the taxpayer.

SECURE also contains advantageous provisions that benefit other aspects of existing retirement plans with incentives for small businesses that start new plans for employees.

And then there’s the advisor who told his client: “I have some bad news concerning the tests results from your underwriting exam!”  Client: “Did I pass?”  Advisor:  “No, but you will in about six months.”

Are Your Trusts Half-Baked? Managing The Sale Of A Trust

It wasn’t too long after I turned my face from home and toward the world that I bumped into the reality of having to fend for myself at mealtime.  With few culinary skills and less patience I quickly adopted the philosophy that if something took longer to make that it did to eat, then the dish wouldn’t have a place on my bill of fare.  The practice is still my prime directive when left to my own devices for the next feed.

That’s not to say I don’t appreciate higher cuisine when those with greater skill and patience are willing to attend.  Nor that aptitude goes unnoticed when the one who prepares a multi-course, multi-dish spread with its varying cook-times and procedures manages to make everything come out in a coordinated manner at the right time.

But it’s really not any different when we are involved in an insurance sale where the policy is to be owned by an irrevocable trust.

The important difference is that you don’t have control over all the elements.

It usually goes something like this:
  • The clients do not want to spend money on a trust till they know they can get insured.
  • Once they get an offer they meet with an attorney to:
    • Figure out what they want.
    • Instruct the attorney to draft the trust.
  • The attorney is as slow as molasses in January.
  • The clock is ticking on the carrier’s offer.
  • The deadline comes and the trust ain’t done.  Sometimes we are able to get an extension on the offer only to find the attorney is even slower than molasses in January.

Despite the fact that the information on the trust that will be the owner and beneficiary of the policy is unknown, work can begin on processing and underwriting.

Simply have the insured/creator of the trust sign the app as insured in all necessary places.  For owner and beneficiary put trust TBD”.  Because the application becomes part of the policy it will be necessary to submit a new Part I prior to issue and after the trust is established with the trustee signing as owner and the trust designated as the beneficiary.

It the worst happens and the trust is not completed before the deadline for delivery then one of two common scenarios usually plays out.  If a grantor trust is anticipated the insured can accept ownership and later sell the policy to the trust.  Because it is not gifted there is no 3-year look-back.  Because it is a grantor trust there is no transfer-for-value.  Some choose an alternative strategy wherein a “surrogate owner” is used who will eventually gift the policy to the trust.  This is dicey.  There is no guarantee the surrogate will, in fact, gift the policy at the appointed time, let alone the proceeds if the insured dies too soon.  In either case there could be significant estate or gift taxes due.

The best approach is, once a medical offer makes the need for a trust evident, to hire an attorney who will confirm in writing that he or she will get the job done in a timely manner.

Taxable Estates: The Do’s And Don’ts Of Designations On Life Policies

Why is it that the most important item on an insurance application is allocated so little space?  Why is it that the second most important item gets equally parsimonious treatment?

All that other stuff is necessary from either a practical or a legal standpoint, but when the dust of policy issue and underwriting have settled and the contract is in force, all that really matters going forward is who owns the policy while the insured is alive and who will get the dough when he or she dies.

Now, having so simply acknowledged this truth – look at the room given on most applications to set down in writing the intentions of the applicant.

The dangerous psychology of the inadequately small boxes is that they seem to suggest that if more room is needed then a client, or an agent or advisor making recommendations, must be excessive at best and obsessive at worst.

The little boxes encourage short, compulsive answers that seem workable at the time, but that could result in disaster if not later re-addressed and cleaned up.

Real-life case in point:

The business owner/proposed insured needs coverage for anticipated estate tax liability (we’re talking several million in coverage).  Time is of the essence because the clock is running on a good underwriting offer.  Everyone is so busy (and hey, who isn’t?) that the advisors and clients can’t get together to talk through the proper structuring the policy.

Finally, the day before the offer will be withdrawn, word comes that for now the policy should be owned by the company (heck, why not, it will be paying the premiums), and the beneficiary will be the insured’s wife.  The first of only two items of good news is that, at least, there is coverage in force.  The other is that the designations commanded are so short that they fit nicely into the boxes on the application.

Other than that there are several potential problems:
  • An “unholy triangle” had been created.  The owner, insured and beneficiary are different parties.  Payment of the death benefit to the spouse could create an income taxable event.  Depending on the manner in which the company was taxed and some other factors this may not be a problem, but nobody took time to think it through.
  • The joint taxable estate of the insured and his wife stands to increase by the amount of the benefit at his death.  Policies purchased to help with estate taxes are held by third parties – usually irrevocable trust whose beneficiaries the same as the insured’s heirs.  This takes planning during the underwriting stages of case.
  • No instructions are given regarding who should be the beneficiary if the wife dies first (maybe it is just as well given that there was no more room in the beneficiary box on the application).  Depending on the contract language the default beneficiary could be either the owner, or the estate of the insured if they are the same.  So now the millions could go into probate court where they are subjected to the expense delay and publicity that attends that process.
Accept three good rules to live by:
  • Be prepared to submit ownership and beneficiary instructions on a separate sheet of paper that is referred to in and is a part of the application.
  • Always submit complete descriptions that include contingent owners and beneficiaries where the primary parties are natural persons.
  • Ask us for help – we will assist as you draft thorough instructions for designation of primary and contingent parties to a policy and will, when necessary, get the blessing of the claims department of the carrier involved.

It always works better when you think outside the box.

Making Heads Or Tails Of Executive Benefits

A simple coin toss is the most popular form of settling disputes or making decisions.  Subterfuge is often used to improve a participant’s odds.  If the caller sees through the “heads-I-win/tails-you-lose” ploy then the flipper can introduce a GMO known as a two-headed coin, usually a Washington quarter, available for a few bucks at any novelty store.

All this to illustrate that, for all the similarity of circumstances that the obverse and the reverse have on the dime, they can dictate significantly diverse patterns of events.  We use the phrase two sides of the same coin to describe the different, but closely related features, of an idea or course of action.  And so it is with certain non-qualified executive benefits.

All employers want economical ways to keep their key people.  You make your coin by helping them decide which side of the opportunities available best meet their needs and goals.

An Executive Bonus plan (EB) is the most common selective benefit format in the business marketplace, and a Death-Benefit-Only Plan (DBO) is the most overlooked.  Both have as their primary purpose to keep a key person with the company by providing life insurance protection.

Their primary difference is the amount of control the employer has – should the executive choose to leave.  Both are easy to explain, implement and administer.

With an EB plan, simply put, the employer pays for the executive’s personal insurance coverage.  In a DBO plan the employer promises to pay a benefit to a named beneficiary if the executive dies while employed, then buys a company-owned policy to fund against the contingency.  In either case the vehicle can be a permanent or term product.

Often with a DBO the employer chooses to roll the policy out to the executive at the time of retirement.  Even with term coverage the conversion privileges can make the transfer attractive if the executive has had health issues.

Consider the different sides of this coin:


Executive Bonus

Death Benefit Only

Policy Owner Executive Employer
Premiums Paid By Employer Employer
Taxation of Premiums Deductible to EmployerTaxable to Executive Not Deductible to EmployerNot Recognizable to Executive
Taxation of Death Benefit During Employment Tax-free to Executive’s BeneficiaryEmployer Not Involved Tax-free to EmployerDeductible When Paid to BeneficiaryTaxable to Beneficiary
Death Benefit After Employment Same – Executive Owns the Policy No Benefit to BeneficiaryEmployer Still Owns the Policy

Call to talk about executive benefits in particular and business planning issues in general that you should be discussing with every business client and prospect you have.

Executive Benefit Opportunities:

For what it’s worth – the simplest of all Super Bowl wagers made by bettors is on the outcome of the opening coin toss.  Those who prefer the NFC did well around and after the turn of the century.  The senior conference won the toss from 1999-2012 defying the odds (going in) of 16,384:1.