After a lifetime of asset accumulation, most of us face federal and state
imposed estate taxes on all we own before assets can be passed on to
children and other heirs. Federal estate tax rates range up to 55% in
addition to state death taxes. The general objectives of estate planning
are to minimize estate taxes, limit exposure to creditor claims, position
our assets in the control of those best suited to manage them, and to
protect loved ones by prearranging asset management for their benefit.
For well informed families there are a myriad of strategies available to
achieve these, and other, objectives and it is common to retain a tax
attorney to guide the family through the strategies and documentation.
The costs associated with lack of preparation can be considerable;
including the forced sale of assets, loss of control of the family
business or investments, shrinkage of income producing assets, and so
forth. Generally, an executor has nine months to settle the estate tax
bill. During that time period vital decisions must be made as to how to
create liquidity for tax payment, business continuity, and generally
redistribute and manage assets during the ownership transition. For many
families this is a difficult time at best.
A well-structured plan will likely employ tools such as gifting
programs, shared ownership, and entitization (placing assets into
different entities, e.g. family limited partnerships, trusts) to achieve
estate tax discounts. Many of the tools achieve tax discounts because
they require relinquishment of some control. Usually there is a point
where families are reluctant to further forgo control over assets to
achieve tax reductions due to concerns that the assets may be needed in
the future or that tax laws may change. In return for flexibility many
will accept some transfer tax.
For the taxes that must be paid, what is the cost of settling estate
taxes with the estate owner's funds? Even if liquid assets are set aside
for estate taxes, the earmarked fund is itself taxable, thus two dollars
are needed for each estate tax dollar due. The fund's earnings would be
income taxable and the entire fund would be subject to creditor claims.
Circumstances and time may be inopportune for creating such a large,
liquid fund before the tax is due. Additionally, an estate has further
challenges, including difficulty in dividing the estate amongst heirs,
loss of family control over key assets, and who would enjoy writing a
large check to the government?
What if there was a means to fund estate taxes at a substantial
discount? Since death triggers the tax payment, we don't truly need
estate tax funding until the second death (the later death of the husband
or wife). Survivorship life insurance policies do exactly that by
insuring both husband and wife, creating liquidity by paying out proceeds
at the second death when estate taxes are due. Survivorship policies cost
approximately half that of insuring each spouse individually, and if
owned properly, the proceeds are free of income tax, estate tax, creditor
claims, and probate. The cumulative premium invested in a survivor life
policy for a healthy 60 year old married couple is approximately 10% of
the death benefit produced (the cost is lower for a younger couple and
higher for an older couple).
Due to the opportunity to exclude life insurance from the taxable
estate, life insurance can be used as a financial tool to deeply discount
estate taxes by providing liquidity at the precise time it is needed.
Policy ownership is important to avoid potential tax pitfalls because if
one owns a policy on their own life the proceeds will be includable in
their estate and subject to estate tax. To avoid estate inclusion of life
insurance proceeds the policy must be owned outside of the estate, by
either a third party or an entity, as you should not be taxed on a policy
you do not own. The choice is predicated on control and flexibility.
The estate planning team uses available techniques and tools to reduce
a family's estate taxes to the lowest practical level given the family's
comfort zone. For the estate taxes that remain, life insurance can act
as an effective tool to assure family control over assets and deeply
discount estate taxes. If dramatic discounts are available through
structured planning why would one want to pay their estate taxes at full