Life Insurance & Charitable Remainder Trusts

Life Insurance and Charitable Remainder TrustsRussell James, J.D., Ph.D., CFP®, Director of Graduate Studies in Charitable Planning, Texas Tech University

Life Insurance Can Be Used as Inheritance Replacement in Charitable Planning

Charitable planning devices such as Charitable Gift Annuities, Gifts of Remainder Interests in Homes and Farms, and Charitable Remainder Trusts produce amazing tax advantages, reducing income taxes, capital gain taxes, and estate taxes

But, they also reduce heirs’ inheritance Charity Donor Heir

Life insurance can diminish this concern

Estate tax law made simple1. Anything you own is taxable at death unless it goes to a spouse or charity2. If your life insurance is owned by another person or an Irrevocable Life Insurance Trust (ILIT) it is not taxable at your death (unless given in prior 3 years)

Because the parent does Insurance Inc.not own the policy, it is not taxed in his estate Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Parent Child Child

Because the parent does Insurance Inc.not own the policy, it is not taxed in his estate Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

The parent can use the Insurance Inc.tax benefit or income from a CGA or CRT to pay for life Estate Tax insurance Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

Charitable Remainder Insurance Inc.Trust (CRT) Estate Tax Free Death Lifetime Benefit Income Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

The child gets a tax free Insurance Inc.inheritance instead of losing up to 55% in estate Estate Tax taxes Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

We give the taxable inheritance to charity, and create income to purchase the non‐ taxable inheritance to give to children

Can it pay to be charitable?Priscilla wants to sell a $1,000,000 non‐income producing zero‐basis asset then spend the interest income of 5% while leaving principal for heirs. Her combined state and federal tax rates are: capital gains (20%) income (40%) estate (55%)

Sale CRUT$1,000,000 asset $1,000,000 asset ‐$200,000 capital gains tax $0 capital gains tax $1,000,000 in 5% unitrust pays $50,000 annually + a charitable tax deduction of $300,000 worth $120,000 + ILIT Client pays $120,000 initially and $10,000 annually for a $400,000 ILIT‐owned policy (including post‐crummey gift taxes)Client uses $40,000/year Client uses $40,000/year($800,000 X 5% return) Charity receives $1,000,000 remainderHeirs receive $360,000 Heirs receive $400,000 ($800,000‐$440,000 est. tax) (tax free from ILIT)

John, age 59, owns $100,000 of farmland which he would like to use for the rest of his life then leave to charity, but he also wants to benefit his heirs. His combined state and federal tax rates are income (40%) and estate (55%).

Giving the remainder interest to charity creates a deduction of $65,553 worth $26,221. This will purchase a paid‐up policy of about $50,000. [Using a 2% §7520 rate; the deduction falls as rates rise, but so does the price of the policy]John keeps lifetime use of farm.Charity gets farm at death.Heirs get $50,000 tax free.

Donor can use money from CRT tax deduction to buy tax free life insurance (ILIT) for children’s inheritance

Wealth replacement through ILIT life insurance creates estate tax free inheritance for family members and allows for charitable giving

Anything Left Initial after Death of Transfer Donor and Kids Payments During Donor Donor Life CRT Charity Payments after Donor’s Death, During Kids Lives Donor kids

Initial Anything Left Transfer at DeathDonor CRT Charity Payments During Life

Anything Left Initial after Death of Transfer Donor and Spouse Payments During Donor Donor Life CRT Charity Payments after Donor’s Death, During Spouse’s Life Donor’s spouse

Anything Left Initial after Death of Transfer Donor and Kids Payments During Donor Donor Life CRT Charity Payments after Donor’s Death, During Kids Lives Donor kids

Anything Left Initial after Death of Transfer Donor and Kids Payments During Donor Donor Life CRT Charity Payments after Donor’s Death, During Kids Lives At donor death, ILIT pays annuity Donor kids

Anything Left Initial after Death of Transfer Donor and Kids Payments During Donor Donor Life CRT Charity At donor death, ILIT pays annuity Donor kids

Mechanics of the ILIT

Donor cannot be ILIT trustee, Insurance Inc.otherwise in donor’s estate Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

Gifts to the ILIT are taxable, thus can Insurance Inc.reduce the available credit for estate tax purposes Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

Gifts to the ILIT are not “present Insurance Inc.interest” gifts, because recipients have to wait to receive benefit Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

We turn the gifts into “present Insurance Inc.interest” gifts by giving beneficiaries the temporary right to get the gift Estate Tax in cash Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Child

We turn the gifts into “present Insurance Inc.interest” gifts by giving beneficiaries the temporary right to get the gift Estate Tax in cash Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

This temporary right to get the gift Insurance Inc.in cash is called a “Crummey” power Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

Of course, we explain to the beneficiary it is best not to take the cash and destroy the planning I don’t feel like using my “crummey” power to take the cash immediately

Gifts for premiums can be gift tax free Insurance Inc.if ≤ $13,000 X beneficiaries X donors annually Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

2 parents to 2 children, spouses, Insurance Inc.and 4 grandchildren2 X 8 X $13,000 = $208,000 per year Estate Tax using “Crummey” Free Death Benefitpowers Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

$208,000 per year can pay for a lot of estate tax free life insurance

The “Crummey” power creates Insurance Inc.another problem Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

When the beneficiary chooses Insurance Inc.not to take the cash, he makes a gift to the other trust beneficiaries Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

This gift is not a “present interest” Insurance Inc.gift, and will reduce the beneficiary’s available estate tax credit Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

But, beneficiary can release greater of Insurance Inc.$5,000 or 5% of trust amount tax free Estate Tax Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

One solution: beneficiary retains Insurance Inc.right to demand cash, except for $5,000/5% annual release (a.k.a. Estate Tax “hanging power” Free Death Benefit Premium Payments Policy on Parent’s Life Money to 30 day Pay right to Premiums take gift Irrevocable Life as cash Insurance Trust Parent (ILIT) Child

Death benefits are also generation Insurance Inc.skipping transfer tax free, therefore excellent planning for grandchildren Estate Tax beneficiaries Free Death Benefit Premium Payments Policy on Parent’s Life Money to Pay Premiums Irrevocable Life Insurance Trust Parent (ILIT) Granchildren

ILIT‐CRT planning creates flexibilityCRT reduces Use part of CRT inheritance payments or tax deduction for ILIT Remove children CRT can pay CRT beneficiaries, to children increase CRT but creates payments to pay for estate taxes tax free ILIT owned life insurance for children

Life Insurance and Charitable Remainder TrustsMore slides and lectures atwww.EncourageGenerosity.com

Life Insurance & Charitable Remainder Trusts

by Russell James

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