This article discusses a technique which gives the insureds control over a survivorship policy and gives the benefits of an irrevocable trust.

 

Because of the unlimited marital deduction, federal estate tax can be eliminated entirely when property passes from one spouse to the other.  All the tax comes due at the second death when the property passes to children or other persons.  For this reason, survivorship policies are extremely popular.  They provide death benefit for estate tax liquidity when it is needed.  However, the ownership of the survivorship policy is often an issue because it could add to the estate tax problem if not structured properly.

 

The irrevocable life insurance trust is commonly used as owner to minimize estate taxes and provide liquidity to meet these unavoidable estate taxes.  Despite its great results, some clients (particularly younger clients) are hesitant to give up all control of the life insurance policy.  They want access to the policy and its cash values and want the ability to change the beneficiary and trustee designations, if necessary, in the future.

 

There is a way to use an irrevocable trust for the survivorship policy, but still maintain the right to change it.  The couple can control the policy and, as their beneficiaries change, they can change the trust.  In addition, with this technique you'll no longer need to delay getting coverage until the trust is in place.

 

Initially, no Crummey notices, gift tax returns, gift tax calculations are necessary since no current gifting is used.

 

The spouse with the shortest life expectancy creates an irrevocable trust. This spouse will also be the sole owner of the survivorship policy, and the irrevocable trust will be contingent owner and beneficiary of the policy.  While this spouse may not terminate the unfunded irrevocable trust, he or she may create a new irrevocable trust and name such trust as new contingent owner and beneficiary at any time.  The new trust will be the controlling trust. At the spouse's death, the irrevocable trust will become the sole owner and beneficiary.

 

As owner, during lifetime this spouse can control the policy.  If the couple wants to change parts of the trust, they simply create a new trust and the owner names the second trust as contingent owner and beneficiary.

 

Owner Dies First:  When the owner dies, the current irrevocable trust will become the owner.  The face amount is not included in the owner's estate because the policy is not mature (the other spouse is still living).  There could, however, be estate tax due on the cash value the deceased spouse owned which has now passed to the trust.  In addition, the surviving spouse may need to start a gifting program to the trust for premium payments.    When the surviving spouse dies, the trust receives the death benefit.  The three year rule would not be a concern under this scenario

 

Nonowner Dies First:  If the nonowner spouse dies first, the result is a little different.  In that situation, the owner should gift the policy to the irrevocable trust at the spouse's death.  If the owner lives more than three years after gifting the policy, the death benefit would be free from estate tax.

 

If the owner dies within three years, the full death benefit would be included in the taxable estate.  The surviving owner can protect against this by gifting money to the irrevocable trust to purchase a term policy to cover these extra taxes on the survivorship policy for three years, if he or she is insurable when the gift is made.  In addition, the surviving spouse may need to gift funds for the survivorship policy premium.

 

While this arrangement does give flexibility, you can see it does involve some risk.  When an irrevocable trust owns the survivorship policy from the onset, there is no estate tax no matter which spouse dies first.

 

Naming the irrevocable trust as contingent owner is not guaranteed to avoid estate tax, but can be very effective when the clients are not ready to be locked into an irrevocable trust and want to use their annual gift tax exclusion for other purposes or retain the right to make changes to will and trusts.  Later when the couple no longer needs the flexibility, the owner can gift the survivorship policy to the irrevocable trust and wait the three years.