21 May 2012 0 Comments

Life Insurance For Estate Planning

The amount of the Federal Estate Tax is currently in a flux, but is unlikely to go away.  So, whether the top bracket is 35% or 55% and whether the exemption is $1,000 or $5,000 per person, substantial estates will likely continue to be hit with a tax due within a stipulated time following death.

In order to pay federal estate taxes within the time limit, many large estates are forced to liquidate their assets – and are devastated as a result. This is why estate planning attorneys often recommend Life Insurance to their clients. A Universal Life policy – or in the case of a couple, a second-to-die Universal Life policy – placed in an Irrevocable Life Insurance Trust (ILIT) provides funds at the exact time they are needed. Properly structured, life insurance proceeds paid to an ILIT are free of estate tax.

The second-to-die policy is used because there is a full marital deduction when bequeathing assets to a spouse who is a U.S. citizen.  So taxes are only due at the second death and this policy is less costly.  For a 65 year-old female and a 68 year-old male who are both Preferred Non-Tobacco Users, the guaranteed annual premium for a $5,000,000 second-to-die Universal Life policy with one company is $65,550. This is a guaranteed premium to age 121.

Is this the best way to provide for estate tax liability?  It certainly is if the husband and wife both die a short time following issue date of the policy.  But, how does it stand up if death of the second of the husband or wife takes place several years later?  To answer this question, determine the Internal Rate of Return (IRR) assuming the second death takes place at various years into the future.  The following table shows the IRR of the death benefit if it is paid at the Policy Years indicated.

Death Benefit Internal Rate of Return (IRR)

Policy Year       IRR%

10                     35.61%

15                    18.64%

20                    11.55%

25                    7.78%

30                    5.49%

35                    3.98%

40                    2.92%

IRR percentage is the after-tax rate of return if death occurs in the year shown. 

In 35 years the wife would be age 100 and the husband age 103.  Unlikely as it is that either of them will be alive at that point, the guaranteed after-tax rate of return of 3.98% looks pretty good even for this extreme case of longevity.

Next I’ll be discussing the use of Permanent Life Insurance when dealing with contractual obligations or providing funds for new or dissident family members or partners.

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