Insurance trusts

Nation's Business, Dec, 1991 by Albert B. Ellentuck

If your assets exceed $600,000, estate taxes could reduce the amount you can leave to your spouse and children.

As noted in the August column, every taxpayer has a $600,000 estate-tax exemption. If this exemption hasn't been reduced by the portion of gifts during your lifetime that exceeded the $10,000 annual limit per donee, and if the estate's assets are worth less than $600,000, the estate should not be subject to an estate tax.

Nevertheless, some types of assets not normally thought of as includable may be included in your estate.

For example, many people know that assets held jointly do not pass through probate. If a husband and wife own their home jointly, the house will pass automatically to the husband on the wife's death and will not pass through the probate court. What few realize, however, is that half the value of the house would be included in the wife's estate for estate-tax purposes.

Life insurance may also be overlooked. Insurance on a husband's life and payable to his wife could be included in his estate for estate-tax purposes even though it would not be part of his probate estate.

To keep the insurance proceeds out of an estate, the policy can be transferred to someone else. For example, if adult children are the beneficiaries and they are responsible individuals, a father may be well-advised to transfer the ownership of the policy directly to them. This means that they will be listed as holders of the policy on the father's life, and they will pay the premiums, be able to obtain the cash value of those policies, and change the beneficiaries if they wish.

Where the spouse is to be the beneficiary, a life-insurance trust may be useful. Take the example of a husband who has $500,000 of other assets and has his wife buy an $800,000 policy on his life. Since the policy is owned by his wife, it would not be includable in his estate, which would remain less than $600,000, and there should be no estate tax. If his wife survives him, her estate, upon her death, would include the $800,000 insurance proceeds and the $500,000 from her husband's estate, and her estate could be taxed as much as $248,000.

A better approach would be to set up a life-insurance trust that would buy the policy, collect and invest the proceeds, and pay the trust income and principal to the wife for life under a specific "approved" standard, such as "health and maintenance needs."

Upon the wife's death, the principal would be distributed to the children.

If properly done, the $800,000 policy could be kept out of not only the husband's estate but also the wife's estate, since she would have had no right to any principal other than that distributed to her under the set standard. In effect, the husband and wife will have transferred $248,000 more to their children.

Tax lawyer Albert B. Ellentuck is a partner in the Washington law firm of Colton and Boykin. Readers should see tax and legal advisers on specific cases.