Ed Slott and life insurance
Salmon Egg
television about tax reduction and avoidance. Although he concentrated
most of his talk on the pitfalls in IRAs and conversions to Roth IRAs,
he said that life insurance was one of the few ways to avoid federal
income tax.
It was not clear to me just how life insurance fitted in with his
program to provide an estate with minimum tax liability. How can life
insurance be used in a way to enhance the value of an estate's
portfolio while not generating tax liability. I can see how the death
benefit can be tax free. But I always thought that life insurance was
useful for providing protection to a family in which the primary bread
winner dies unexpectedly. I have always looked at life insurance as a
poor investment vehicle. It does not seem reasonable to use life
insurance just because it can be tax free. What am I missing?
Bill
--
An old man would be better off never having been born.
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Stuart A. Bronstein
> It was not clear to me just how life insurance fitted in with
> his program to provide an estate with minimum tax liability. How
> can life insurance be used in a way to enhance the value of an
> estate's portfolio while not generating tax liability. I can see
> how the death benefit can be tax free. But I always thought that
> life insurance was useful for providing protection to a family
> in which the primary bread winner dies unexpectedly. I have
> always looked at life insurance as a poor investment vehicle. It
> does not seem reasonable to use life insurance just because it
> can be tax free. What am I missing?
Life insurance is generally free from income tax, but is generally
subject to estate tax. However with a proper life insurance trust,
the death benefit can be free of estate tax as well.
Someone with a large estate is looking at a marginal rate of up to
50% or perhaps even more. Money spent on life insurance premiums
are out of the estate. So even if more money is spent on insurance
than the death benefit, it can result in a net gain after taxes.
Example: A buys $1,000,000 of life insurance and pays $100,000 per
year. He lives another 15 years, paying a total of $1.5 million,
while his estate gets a death benefit of $1 million.
However his estate is $1.5 million lighter as a result of the
payments, saving his estate half, meaning an effective cost of
$750,000. The death benefit is free of income tax and estate tax,
so there is a net benefit of $250,000.
--
Stu
http://downtoearthlawyer.com
kastnna
> I just finished watching a program presented by Ed Slott on PBS
> television about tax reduction and avoidance. Although he concentrated
> most of his talk on the pitfalls in IRAs and conversions to Roth IRAs,
> he said that life insurance was one of the few ways to avoid federal
> income tax.
>
> It was not clear to me just how life insurance fitted in with his
> program to provide an estate with minimum tax liability. How can life
> insurance be used in a way to enhance the value of an estate's
> portfolio while not generating tax liability. I can see how the death
> benefit can be tax free. But I always thought that life insurance was
> useful for providing protection to a family in which the primary bread
> winner dies unexpectedly. I have always looked at life insurance as a
> poor investment vehicle. It does not seem reasonable to use life
> insurance just because it can be tax free. What am I missing?
>
> Bill
As you alluded, life insurance death benefits are, typically, income
tax free to the recipient. There are some unique situations involving
qualified plans and/or corporate ownership that makes life insurance
partially income taxable, but that is probably not what you are
referring to. However, if the deceased was also the owner, or
exercised any incidences of ownership, then the death proceeds are
includable in the gross estate of the deceased and possibly subject to
estate taxation. I THINK this is what you are referring to in your
post.
However, there is no rule that says the owner of the policy MUST be
the insured. By using an irrevocable life insurance trust, or some
similar vehicle, it is possible to have an insurance policy that is
both free from income AND estate taxes. Not having seen Mr. Slott's
presentation, I can only guess that this is what he was speaking
about.
And as you state, I too think that life insurance MIGHT BE a poor
investment vehicle although I can make arguments for each side.
Typically the ROI on a permanent insurance policy for the average
person (i.e. living a normal life expectancy) is somewhere in the
neighborhood of 4-6%. But keep in mind that is both tax-free and tax-
deferred. At the same time, the S&P 500 has historically returned an
average ROI much higher than that. However, investing in the S&P also
entails accepting significantly more risk and many people are
beginning to think that the US economy is entering a phase in its
growth cycle in which those historical averages may not be sustainable
anymore. But that's all just speculation...
Salmon Egg
Salmon Egg <Salm...@sbcglobal.net> wrote:
> I just finished watching a program presented by Ed Slott on PBS
> television about tax reduction and avoidance. Although he concentrated
> most of his talk on the pitfalls in IRAs and conversions to Roth IRAs,
> he said that life insurance was one of the few ways to avoid federal
> income tax.
>
> It was not clear to me just how life insurance fitted in with his
> program to provide an estate with minimum tax liability. How can life
> insurance be used in a way to enhance the value of an estate's
> portfolio while not generating tax liability. I can see how the death
> benefit can be tax free. But I always thought that life insurance was
> useful for providing protection to a family in which the primary bread
> winner dies unexpectedly. I have always looked at life insurance as a
> poor investment vehicle. It does not seem reasonable to use life
> insurance just because it can be tax free. What am I missing?
After thinking about this a while, I might have an idea on how life
insurance is to be used.
Slott was pushing the idea of using non-IRA funds for paying taxes for
the Roth conversion. Doing that allows to maximize the principle that
accumulates a tax free investment return. Life insurance provides a tax
free source of funds to heirs to use to extend the length that the
inherited IRAs can work.
I will admit to not understanding this completely. Because I was so
impressed by Slott's presentation, I made a donation to the PBS station
that broadcast Plott's presentation. I donated enough to obtain Plott's
DVDs and other tax planning materials as a membership premium. Now, I
will be able to give full attention to what he said.
One thing Plott said that would be of interest to this group is to avoid
handling funds being transferred from one IRA to another. I was thinking
of doing the exact same thing by making use of the 60 day window
available to do so. He pointed out that such a transfer can be made only
once per year while IRA transfers between financial institution are not
limited by those requirements. He also said that many things can happen
during those 60 days to void the tax free transfer.
D. Stussy
news:Xns9DD35994F9BD2s...@130.133.4.11...
> Salmon Egg <Salm...@sbcglobal.net> wrote:
> > It was not clear to me just how life insurance fitted in with
> > his program to provide an estate with minimum tax liability. How
> > can life insurance be used in a way to enhance the value of an
> > estate's portfolio while not generating tax liability. I can see
> > how the death benefit can be tax free. But I always thought that
> > life insurance was useful for providing protection to a family
> > in which the primary bread winner dies unexpectedly. I have
> > always looked at life insurance as a poor investment vehicle. It
> > does not seem reasonable to use life insurance just because it
> > can be tax free. What am I missing?
>
> Life insurance is generally free from income tax, but is generally
> subject to estate tax. However with a proper life insurance trust,
> the death benefit can be free of estate tax as well.
Hint: Life insurance is estate tax free if the person who pays the
premiums is NOT the decedent (therefore, it doesn't get included in the
estate). Spouses should pay each OTHER's policy, not their own.
(Or at least, that's the way it used to work. I haven't dealt with this
issue for over a decade.)
Stuart A. Bronstein
> "Stuart A. Bronstein" <spam...@lexregia.com> wrote
>> Life insurance is generally free from income tax, but is
>> generally subject to estate tax. However with a proper life
>> insurance trust, the death benefit can be free of estate tax as
>> well.
>
> Hint: Life insurance is estate tax free if the person who pays
> the premiums is NOT the decedent (therefore, it doesn't get
> included in the estate). Spouses should pay each OTHER's
> policy, not their own.
It's more complicated than who pays the premiums, though that is a
rule of thumb. It's who the owner of the policy is. There are
many incidents of ownership, and whoever can exercise any of them
(e.g. right to change the beneficiary, right to borrow against the
cash value etc.) is considered an owner for this purpose.
Going through all the trouble of making sure a spouse has all
incidents of ownership for a policy that she will be the
beneficiary of is a waste of time. Since there is an unlimited
marital deduction, you shouldn't bother. In fact, it would be best
for the death benefit, if it is to benefit the other spouse, to be
included in a testementary trust that has a marital deduction trust
included.
--
Stu
http://downtoearthlawyer.com
D. Stussy
news:Xns9DD3747E03693s...@130.133.4.11...
> "D. Stussy" <spam+ne...@bde-arc.ampr.org> wrote:
> > "Stuart A. Bronstein" <spam...@lexregia.com> wrote
> >> Life insurance is generally free from income tax, but is
> >> generally subject to estate tax. However with a proper life
> >> insurance trust, the death benefit can be free of estate tax as
> >> well.
> >
> > Hint: Life insurance is estate tax free if the person who pays
> > the premiums is NOT the decedent (therefore, it doesn't get
> > included in the estate). Spouses should pay each OTHER's
> > policy, not their own.
>
> It's more complicated than who pays the premiums, though that is a
> rule of thumb. It's who the owner of the policy is. There are
> many incidents of ownership, and whoever can exercise any of them
> (e.g. right to change the beneficiary, right to borrow against the
> cash value etc.) is considered an owner for this purpose.
>
> Going through all the trouble of making sure a spouse has all
> incidents of ownership for a policy that she will be the
> beneficiary of is a waste of time. Since there is an unlimited
> marital deduction, you shouldn't bother. In fact, it would be best
> for the death benefit, if it is to benefit the other spouse, to be
> included in a testementary trust that has a marital deduction trust
> included.
One never knows when Congress will pull or limit the marital deduction.
Why not protect against that too? Also, it keeps the insurance out of the
estate to begin with - which may have other effects (either now or in the
future).
Exclusions are often better than deductions. ;-)
removep...@yahoo.com
> I will admit to not understanding this completely. Because I was so
> impressed by Slott's presentation, I made a donation to the PBS station
> that broadcast Plott's presentation. I donated enough to obtain Plott's
> DVDs and other tax planning materials as a membership premium. Now, I
> will be able to give full attention to what he said.
Cool. How will you determine the FMV of the DVD? Your donation minus
the DVD (and minus other goodies they sometimes give you like a
magazine subscription) are deductible on Schedule A.
removep...@yahoo.com
wrote:
> "Stuart A. Bronstein" <spamt...@lexregia.com> wrote in messagenews:Xns9DD3747E03693s...@130.133.4.11...
> > >> Life insurance is generally free from income tax, but is
> > >> generally subject to estate tax. However with a proper life
> > >> insurance trust, the death benefit can be free of estate tax as
> > >> well.
Is the value of the trust included in the decedent's estate? Maybe it
depends on whether the trust is revocable or irrevocable. If the
value of the trust is not included in the decedent's estate, it looks
like a loophole -- another source of tax revenue to fund laws like
"The Education Jobs and Medicaid Assistance Act of 2010".
Just read up on revocable versus irrevocable trusts. They say value
of irrevocable trust is not included in estate. Out of curiosity,
when you transfer money to such a trust, does the gift tax apply?
> > > Hint: Life insurance is estate tax free if the person who pays
> > > the premiums is NOT the decedent (therefore, it doesn't get
> > > included in the estate). Spouses should pay each OTHER's
> > > policy, not their own.
How does this matter? Say husband and wife both have life insurance
policies worth $500,000. Say husband owns wife's policy, and vice
versa. Say wife dies. Then her estate will include her husband's
life insurance policy as she was the owner of it. And when the
husband dies, his wife's insurance policy will be included in his
estate. There's no avoiding adding $500,000 to the estate.
> > Going through all the trouble of making sure a spouse has all
> > incidents of ownership for a policy that she will be the
> > beneficiary of is a waste of time. Since there is an unlimited
> > marital deduction, you shouldn't bother. In fact, it would be best
> > for the death benefit, if it is to benefit the other spouse, to be
> > included in a testementary trust that has a marital deduction trust
> > included.
If the beneficiary of the life insurance is not the surviving spouse
but instead are the kids, then it does matter. But in 2010 there is
no estate exemption, so it does not matter.
> One never knows when Congress will pull or limit the marital deduction.
> Why not protect against that too? Also, it keeps the insurance out of the
> estate to begin with - which may have other effects (either now or in the
> future).
When they pull the plug, then we can deal with it. Dealing with the
issue prematurely may cause complications. Anyway, there's probably
more chance of section 121 being repealed than the marital exclusion
going away.
JoeTaxpayer
> On Aug 13, 11:29 am, Salmon Egg<Salmon...@sbcglobal.net> wrote:
>
>> I will admit to not understanding this completely. Because I was so
>> impressed by Slott's presentation, I made a donation to the PBS station
>> that broadcast Plott's presentation. I donated enough to obtain Plott's
>> DVDs and other tax planning materials as a membership premium. Now, I
>> will be able to give full attention to what he said.
>
> Cool. How will you determine the FMV of the DVD? Your donation minus
> the DVD (and minus other goodies they sometimes give you like a
> magazine subscription) are deductible on Schedule A.
Off the original topic, but - Charities will give you a receipt. It will
state "no item of value were given" or FMV of the gift.
They value at full value. My Lake Wobegone mug which I treasure,
basically cost me $13. The DVD is not the 50cents it cost to stamp out,
but likely $49 or so. (I am a Slott fan, but I'd have DVR'd a show that
was broadcast)
Joe
dpb
...
> After thinking about this a while, I might have an idea on how life
> insurance is to be used.
>
> Slott was pushing the idea of using non-IRA funds for paying taxes for
> the Roth conversion. Doing that allows to maximize the principle that
> accumulates a tax free investment return. Life insurance provides a tax
> free source of funds to heirs to use to extend the length that the
> inherited IRAs can work.
>
> I will admit to not understanding this completely. Because I was so
> impressed by Slott's presentation, I made a donation to the PBS station
> that broadcast Plott's presentation. I donated enough to obtain Plott's
> DVDs and other tax planning materials as a membership premium. Now, I
> will be able to give full attention to what he said.
...
I didn't see the program (thanks to the digital conversion "help", we
can no longer receive a PBS signal) so can't comment on it directly.
Thus don't know if it was part of the presentation and/or strategy but
another possibility is the use of "second-to-die" insurance for estate
planning.
--
kastnna
wrote:
> "Stuart A. Bronstein" <spamt...@lexregia.com> wrote in messagenews:Xns9DD3747E03693s...@130.133.4.11...
>
>
>
>
>
> > "D. Stussy" <spam+newsgro...@bde-arc.ampr.org> wrote:
>
> - Show quoted text -
Having your spouse own your policy still causes a problem if they die
FIRST. The policy on your life will be included in the spouses estate
which means that any cash value (or the interpolated terminal reserve)
will ge added to THEIR gross estate. In spite of the uniform
simultaneous death act, it still gets pretty hairy if both spouses die
at the same time as well (e.g. a car accident).
Like Stuart said, as it currently stands the unlimited marital
deduction would still save the day. But to turn your own argument
against you, "One never knows when Congress will pull or limit the
marital deduction. Why not protect against that too?"
Again, an irrevocable trust avoids all of the, thus far mentioned,
problems and is low cost, low administration relative to the sums of
money involved.
Stuart A. Bronstein
> "D. Stussy" <spam+newsgro...@bde-arc.ampr.org> wrote:
>> "Stuart A. Bronstein" <spamt...@lexregia.com> wrote
>
>> > >> generally subject to estate tax. However with a proper
>> > >> life insurance trust, the death benefit can be free of
>> > >> estate tax as well.
>
> Is the value of the trust included in the decedent's estate?
No, it's the death benefit that's included in the estate. However
if it's a community property state and the deceased is married,
only half may be included in the estate.
> Maybe it depends on whether the trust is revocable or
> irrevocable. If the value of the trust is not included in the
> decedent's estate, it looks like a loophole -- another source of
> tax revenue to fund laws like "The Education Jobs and Medicaid
> Assistance Act of 2010".
Insurance trusts are irrevocable. But there is a whole lot more to
them than that. If they are not precisely drafted and carried out,
the death benefit will again be taxed in the estate.
> Just read up on revocable versus irrevocable trusts. They say
> value of irrevocable trust is not included in estate. Out of
> curiosity, when you transfer money to such a trust, does the
> gift tax apply?
Again, it's a lot more complicated that that. Whether a trust is
revocable or irrevocable is only one of many issues that must be
determined. If a trust is revocable it is certainly included in
the estate. But if it's irrevocable, it may or may not, depending
on several other factors.
>> > > Hint: Life insurance is estate tax free if the person who
>> > > pays the premiums is NOT the decedent (therefore, it
>> > > doesn't get included in the estate). Spouses should pay
>> > > each OTHER's policy, not their own.
>
> How does this matter? Say husband and wife both have life
> insurance policies worth $500,000. Say husband owns wife's
> policy, and vice versa. Say wife dies. Then her estate will
> include her husband's life insurance policy as she was the owner
> of it. And when the husband dies, his wife's insurance policy
> will be included in his estate. There's no avoiding adding
> $500,000 to the estate.
That's why it's better to use a trust, and keep the death benefit
out of both estates.
--
Stu
http://downtoearthlawyer.com
D. Stussy
> "removep...@yahoo.com" <removep...@yahoo.com> wrote:
> > "D. Stussy" <spam+newsgro...@bde-arc.ampr.org> wrote:
> >> "Stuart A. Bronstein" <spamt...@lexregia.com> wrote
> > insurance policies worth $500,000. Say husband owns wife's
> > policy, and vice versa. Say wife dies. Then her estate will
> > include her husband's life insurance policy as she was the owner
> > of it. And when the husband dies, his wife's insurance policy
> > will be included in his estate. There's no avoiding adding
> > $500,000 to the estate.
>
> That's why it's better to use a trust, and keep the death benefit
> out of both estates.
...But the policy isn't actually worth $500k as the husband hasn't yet
died. It may be worth ONLY its paid-in premiums (i.e. liquidation value).
It's a contingent asset where the contingency was not realized during the
decedent's death (therefore, face value doesn't apply), especially if the
policy is non transferable.
The estate includes the liquidation value of the wife's policy covering the
husband.*
The husband gets $500k for his policy covering the wife income and estate
tax free (with respect to her death).
(At this point, there are no existing policies that continue forward.)
That's the magic of life insurance.
Yes, the estate of the latter to die may include (what's left of) the
policy payout of the former to die. However, if it has been spent on
non-assets and non-liabilities(i.e. living expenses, etc.), there may be
nothing left to tax when the latter dies.
For transferable policies, then one pushes the payout of the surviving
spouse to the children in order to keep it out of the latter's estate.
What matters is that there are ways of legally making the payouts free from
both taxes, if properly planned and designed.
* - If they had not bought the insurance policies, this is the amount of
cash/equivalent that would otherwise be sitting in her estate anyway.
kastnna
wrote:
> ...But the policy isn't actually worth $500k as the husband hasn't yet
> died. It may be worth ONLY its paid-in premiums (i.e. liquidation value).
> It's a contingent asset where the contingency was not realized during the
> decedent's death (therefore, face value doesn't apply), especially if the
> policy is non transferable.
But it is not only worth its paid-in premiums. Depending upon the type
of policy, it could be worth nearly nothing (e.g. term) or it could be
significantly more valuable than not only the premiums paid in, but
the cash surrender value as well. For years now, the IRS has been
favoring the interpolated terminal reserve formula for determining a
policy's true "worth" at any given time prior to maturity. In the
past, the cash surrender value was used, which was still often much
higher than the value of the premiums paid in.
> The estate includes the liquidation value of the wife's policy covering the
> husband.*
> The husband gets $500k for his policy covering the wife income and estate
> tax free (with respect to her death).
> (At this point, there are no existing policies that continue forward.)
Again, it's incorrect to assume that the policy's worth is the
summation of premium paid-in.
> That's the magic of life insurance.
>
> Yes, the estate of the latter to die may include (what's left of) the
> policy payout of the former to die. However, if it has been spent on
> non-assets and non-liabilities(i.e. living expenses, etc.), there may be
> nothing left to tax when the latter dies.
Why bother with the "IF"? Using an ILIT, the spouse doesn't have to
spend it all. Most of the families I work with actually want to pass
on as much to their children as possible, not spend the last dollar on
their death bed.
An ILIT will also shield both the policy (prior to maturity) and the
proceeds (after payout) from creditors. Having the spouse own the
policy does not accomplish such as it is still exposed to the spouse's
creditors and potential even the insured's creditors (each state's
exemption laws are unique and should be researched independently).
And, as previously mentioned, dual death situations (e.g. car
accidents) can be an absolute mess in spouse-owned policy
arrangements.
Nevermind the potential spendthrift provisions that can be included in
an ILIT. Too often, one member of the marriage manages all the
financial affairs and the other spouse is clueless as to how to manage
finances. Or try dumping a couple million bucks on a, legally adult,
20 year old. But all that is outside the scope of the insurance
aspect.
> For transferable policies, then one pushes the payout of the surviving
> spouse to the children in order to keep it out of the latter's estate.
Again, why deal with the potential risks? Life insurance is subject to
the "3 year look-back in anticipation of death" rules. Any transfer of
a policy without adequate consideration within 3 years of death is
brought back into the decedent's estate for estate tax purposes.
Then again, any transfer of an insurance policy to your children FOR
adequate consideration violates the transfer for value rules and thus
the policy loses its "income tax free" status. Damned if ya do, damned
if ya don't....
> What matters is that there are ways of legally making the payouts free from
> both taxes, if properly planned and designed.
Agree completely. And I'm all for DIY. Heck, I just changed out all 12
spark plugs in my car last weekend. But, IMO, some things are too
important to DIY. Estate planning is usually one of those things. A
couple thousand of dollars in good estate planning can literally save
millions in future taxes. I just don't get why people fight it so
much.
Just my $0.01 (it's been a rough decade)!