Let's set up a hypothetical. Married couple age 40. Two children ages 10 and 12. Total value of their combined estate is $2.5 million.
Equity in home = $200k
Qualified Retirement Plan (i.e. IRA) = $200k
Stocks and Bonds = $100k
Term Life Insurance = $2 million
If we take the advice of the previous article and include a credit shelter trust into the couple's Wills, then all but $500k will be exempt from estate taxes (assuming both husband and wife die with a $1 million exemption amount).
The $500k could be subject to estate taxes at a top rate of 55% in 2011. But we can avoid all estate taxes if a life insurance policy is owned by an Irrevocable Life Insurance Trust ("ILIT"). An ILIT is one of a few techniques available to estate planning attorney to enable clients to transfer property to family members without having the property included in their estates at death.
Let's assume the life insurance policy is a ("Survivor Policy"), which insures both husband and wife and pays the proceeds on death of the second spouse to die. Now let's assume the couple establishes an ILIT, then transfers the existing insurance policy to the ILIT. The couple then transfers liquid assets sufficient to pay the first year's premium to the ILIT. Each year, the donor makes a gift to the ILIT sufficient to pay the premiums due. The children, as named beneficiaries, are given a 30 day "Crummy" right to withdraw the contributions (which they never exercise) so that each contribution is exempt from gift taxes.
At death, the life insurance proceeds are paid to the ILIT and distributed to beneficiaries under the terms of the ILIT. If the couple lives for three years after the transfer of the existing policy to the ILIT, then at death, the policy is totally excluded from their estates, which means the last spouse to die will only have a $500k estate and the children won't have to pay any federal estate taxes.
The trustee of the ILIT should be a third party (i.e. a trusted sibling or friend). Upon the death of the both spouses, the trustee will manage the property for any minor children until a certain age or ages at which point the trust proceeds may be distributed to the children outright.
In sum, the ILIT is a great way to transfer wealth to the next generation while avoiding estate taxes. As 2011 draws near, it is becoming more and more likely that we might be looking at a $1 million exemption per person. The lower the exemption the more ILITs will be used to transfer wealth.