Estate taxes and Irrevocable Life Insurance Trusts

[nun]

So I've reached the goals of FIRE and now I'm thinking about estate planning. I have enough income from rent and a DB plan to cover my expenses and so my investments and DC pensions are left to compound. I don't expect to have to worry about Federal IHT, but I'm already over the $1M estate tax threshold of the state where I live just on the value of my house. So I'm looking into ways to minimize tax. As I'm single I can't use a spouses exemption, I've considered simply moving to a state with a higher threshold, and giving to charity and using the $15k/person gift allowance, but the other option seems to be funding an Irrevocable Life Insurance Trust. This is where a trust holds a Permanent Life Insurance policy (I'm costing Universal Life from TIAA) and I gift the trust the annual premiums up to the annual gift tax exemption amount. The gift reduces the value of the estate, but more importantly the death benefit is tax free and can be used to pay state estate taxes and there might be something left over.

I need to do the math to see if the premiums would be better spent just staying invested, and I can give my heirs gifts to reduce the estate, but I first need to find out how much Universal Life coverage I might get as a healthy mid 50's guy. Has anyone considered or done this? Is it worth while? or is it like all the other things involving permanent life insurance....a bit of a gimmick?

[ERD50]

"or is it like all the other things involving permanent life insurance....a bit of a gimmick? :

Yes, mostly, IMO.

The question is, would your estate have the liquidity to pay those state Estate taxes (say that 10 times fast!)? If you are lacking liquidity, then some insurance might make sense, but there are probably cheaper ways to obtain liquidity, and make sure the insurance really can be obtained in a short time (beneficiaries are all in order, and have the info they need to make the claim. We went through several iterations to get the checks for two small policies for my MIL. The ins co sure doesn't make it easy.

Beyond that, you are really trying to say that insurance is a good investment, and few outside the insurance industry would defend that. Just gift what you can (that's totally flexible, start/stop at any time you wish). And if liquidity is an issue, are there other option?

How soon after date-of-death are your state Estate taxes due?

-ERD50

[CaliKid]

Life insurance is great if it's avoiding federal estate tax as it's at such a much higher rate (maybe 35%). Most states are like 10% at the most. I personally wouldn't worry about it. In my opinion a 10% tax is not worth the complications or cost of an ILIT. Just live your life and let the tax be paid after death IF the exemption has not increased by that time.

[gcgang]

If you do it, make sure the UL policy can't lapse. Whole life would also be something to consider.

I think there's also some documentation recommended on the annual gifts of premium.

[ERD50]

Quote:

Originally Posted by nun .... I gift the trust the annual premiums up to the annual gift tax exemption amount. The gift reduces the value of the estate, but more importantly the death benefit is tax free ...

Quote:

Originally Posted by CaliKid Life insurance is great if it's avoiding federal estate tax ....

This wording is disingenuous at best, IMO, and is often used as a sales pitch for insurance.

Yes, you can say the death benefit is tax free, but so were the premiums used to pay for the insurance. So if you keep it apples-apples, one tax-free amount to fund another tax free amount boils back down to "is insurance a good investment?". The answer is generally not.

So there is no 'avoidance' of Fed Estate tax - it is just a shifting from one form to another. A form where an insurance salesperson can make a commission, so can be expected to talk it up.

-ERD50

[GrayHare]

Note that bequests you leave to charity are not subject to the Federal estate tax. Sufficient charitable giving to drop your estate below the threshold can eliminate that tax, at least as the laws are currently written.

[CaliKid]

Quote:

Originally Posted by ERD50 This wording is disingenuous at best, IMO, and is often used as a sales pitch for insurance. Yes, you can say the death benefit is tax free, but so were the premiums used to pay for the insurance. So if you keep it apples-apples, one tax-free amount to fund another tax free amount boils back down to "is insurance a good investment?". The answer is generally not. So there is no 'avoidance' of Fed Estate tax - it is just a shifting from one form to another. A form where an insurance salesperson can make a commission, so can be expected to talk it up. -ERD50

I agree with you but one of the nice features about purchasing life insurance is that it's forced savings for the inheritors. Any kid/beneficiary with a brain is going to keep paying the premiums rather than blowing it on big screen TV and a new car. Also, life insurance is an incredible investment if the person dies prematurely. It sucks for the person who died but the ROI is off the charts if they die after only a few years of premium payment. Just facts.

[ERD50]

Quote:

Originally Posted by CaliKid ....Also, life insurance is an incredible investment if the person dies prematurely. It sucks for the person who died but the ROI is off the charts if they die after only a few years of premium payment. Just facts.

Yes, but that's not really an investment, it's a gamble/speculation.

But that's why it might make sense if there are no better liquidity solutions. The amount will be available at death, regardless of when the death occurs (not factoring inflation).

-ERD50

[nun]

Quote:

Originally Posted by ERD50 "or is it like all the other things involving permanent life insurance....a bit of a gimmick? : Yes, mostly, IMO. The question is, would your estate have the liquidity to pay those state Estate taxes (say that 10 times fast!)? If you are lacking liquidity, then some insurance might make sense, but there are probably cheaper ways to obtain liquidity, and make sure the insurance really can be obtained in a short time (beneficiaries are all in order, and have the info they need to make the claim. We went through several iterations to get the checks for two small policies for my MIL. The ins co sure doesn't make it easy. Beyond that, you are really trying to say that insurance is a good investment, and few outside the insurance industry would defend that. Just gift what you can (that's totally flexible, start/stop at any time you wish). And if liquidity is an issue, are there other option? How soon after date-of-death are your state Estate taxes due? -ERD50

There's no problem with liquidity..all I have is a house and the usual retirement and investment accounts and there will be enough in them to pay any estate taxes. FYI if I die tomorrow there'd be an 8% state estate tax on everything above $40k and no federal tax. I also found this very useful blog post and maybe buying an equity index fund inside the trust is better than the life insurance.....or maybe the bother of the trust isn't worth it and the uncertainties make it too hard to chose.

https://www.whitecoatinvestor.com/yo...vocable-trust/

[nun]

Quote:

Originally Posted by CaliKid I agree with you but one of the nice features about purchasing life insurance is that it's forced savings for the inheritors. Any kid/beneficiary with a brain is going to keep paying the premiums rather than blowing it on big screen TV and a new car.

My heirs won't be paying anything...but I'll have to notify them of the gift to fund the trust

Quote:

Also, life insurance is an incredible investment if the person dies prematurely. It sucks for the person who died but the ROI is off the charts if they die after only a few years of premium payment. Just facts.

That's what Phyllis Dietrichson said to Walter Neff

[nun]

Quote:

Originally Posted by GrayHare Note that bequests you leave to charity are not subject to the Federal estate tax. Sufficient charitable giving to drop your estate below the threshold can eliminate that tax, at least as the laws are currently written.

I'm not worried about Federal, it's state taxes. If the estate goes above $1M then everything above $40k is taxed on a progressive scale. The obvious solution is to move to Florida.

Actually as the max state tax rate I could currently pay is 16% just letting the money grow outside a trust isn't such a bad option and there will be costs in administering the trust too.

[Sunset]

Another BIG problem with insurance is that it only pays after you are dead.
Why is this a problem, because you are not there with all the records to show they need to pay.
Some insurance companies don't pay if it can be avoided, and they work hard to not pay. It's not illegal, they will just dispute various things for years to avoid paying.

If the heirs are not even aware, then the insurance company may not pay as nobody claimed.

[Sunset]

If anyone wants to decrease their estate, I think the $15k/person gift allowance is a great way to start.

And, let's be real, it's easy to add another few thousand cash at various times throughout the year for birthdays, etc.

[nun]

Quote:

Originally Posted by Sunset Another BIG problem with insurance is that it only pays after you are dead. Why is this a problem, because you are not there with all the records to show they need to pay. Some insurance companies don't pay if it can be avoided, and they work hard to not pay. It's not illegal, they will just dispute various things for years to avoid paying. If the heirs are not even aware, then the insurance company may not pay as nobody claimed.

The life insurance is owned by the trust and it's the trustees that will do everything to get the payout. Also the beneficiaries of the trust must be kept informed about the status and every year a gift is given to the trust to pay the premiums they need to be told that and given the option to take the gift themselves.

FYI TIAA just gave me a whole life quote assuming good health mid 50's male of $18k/year for $1M death benefit. Which looks good if I die tomorrow, but not so good if I live another 30 years. I'm not sure if this is the right type of policy or if I could get something cheaper.

[nun]

Quote:

Originally Posted by Sunset If anyone wants to decrease their estate, I think the $15k/person gift allowance is a great way to start. And, let's be real, it's easy to add another few thousand cash at various times throughout the year for birthdays, etc.

The $15k per person gift allowance could also be used to fund the Irrevocable Trust....instead of giving the money to relatives it can go into the trust without any gift tax issues and reduces the value of the estate in the same way. Instead of buying life insurance with that money it could be used to buy mutual funds. The trust would have to pay tax on the investment each year, but the return would probably be better than the life insurance if I have an average life span. The issue is whether the added expense of the trust and the capital gains tax that would be due on the mutual funds when the trust pays out gives a better result than just keeping the money in the estate and letting it grow and then paying the estate tax and my heirs inherit the money with a step up basis.....

Trust....reduces value of estate, but has added expenses and capital gains at death.

No trust....does not reduce estate value, but lower expenses, more flexible, no capital gains on death, but estate tax to pay.

I think for the Federal estate tax of 40% the trust is a good bet even if it might cost an extra 1% or 2% in fees, but my max state estate tax is 16% so the trust vs no-trust is a less obvious choice.