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Planning for Tax-Qualified Plans

Volume 2, Issue 4

Planning for tax-qualified plans, which includes IRAs, 401(k)s and qualified retirement plans, requires a careful examination of the potential taxes that impact these assets. Unlike most other assets that receive a “basis step-up” to current fair market value upon the owner’s death, IRAs, 401(k)s and other qualified retirement plans do not step-up to the date-of-death value.

Therefore, beneficiaries who receive these assets do so subject to income tax. If the estate is subject to estate tax, the value of these assets may be further reduced by federal and perhaps state estate tax. And if your clients name grandchildren or younger generations as beneficiaries, these assets may additionally be reduced by the generation-skipping transfer tax – at the highest federal estate tax rate. All told, these assets may be subject to 70% tax or more.

There are several strategies available to your clients to help reduce the impact of these taxes and to ensure that these assets meet each client’s unique planning objectives. This issue of our newsletter examines some of the more common planning alternatives for tax-qualified plans, as well as the advantages and disadvantages of each.

Structure Accounts to Provide the Longest Term Payout Possible

Structuring tax-qualified plans to provide the longest term payout possible is the most common option. With this strategy your clients name beneficiaries in a way that requires the beneficiaries to withdraw the least amount possible as required minimum distributions (those distributions that the beneficiaries must take in order to avoid a 50% penalty).

Frequently, married clients name the surviving spouse as the primary beneficiary so that the survivor may roll over the account into his or her name and treat the account as his or her own. The surviving spouse then names younger beneficiaries for stretch-out purposes.

To achieve the maximum “stretch-out,” your clients should name beneficiaries who are young (e.g., children or grandchildren, although there are special considerations when naming grandchildren or younger generations). The younger the beneficiary, the smaller the required minimum distributions. To achieve maximum income tax deferral, beneficiaries should take only their required minimum distributions.

Your clients can accomplish this strategy by naming the beneficiaries individually. Alternatively, if your clients are concerned about the loss of creditor or divorce protection that occurs when they name beneficiaries outright, they can name a beneficiary’s share of a trust as the designated beneficiary of their tax-qualified plans.

Planning Tip:  Structuring tax-qualified accounts for maximum “stretch-out” makes sense from an income tax perspective. However, naming a beneficiary outright may subject the account to the beneficiary’s creditors or former spouse upon divorce. Consider naming a trust as designated beneficiary to ensure that the account passes to the client’s intended beneficiaries – and in the manner intended by the client.

Name a Retirement Trust as Beneficiary to Ensure the Longest Term Payout Possible

Naming a beneficiary outright to accomplish tax deferral with a tax-qualified plan has several disadvantages. First, if the beneficiary is very young, the distributions must be paid to a guardian; if the beneficiary has no guardian, a court must appoint one. Another disadvantage is the potential loss of creditor protection or bloodline protection, particularly where the named beneficiary is the surviving spouse.

A third, practical disadvantage is that many beneficiaries take distributions much larger than the required minimum distributions. In fact, studies show that beneficiaries consistently consume this “found money” in only a couple of years – regardless of the amount in the account or the age of the beneficiary.

However, by naming a trust as the beneficiary of tax-qualified plans, your client can ensure that the beneficiary defers the income and that these assets remain protected from creditors or a former son- or daughter-in-law. A stand-alone retirement trust (separate from a revocable living trust and other trusts) can further help ensure that it accomplishes your client’s objectives while also ensuring the maximum tax deferral permitted under the law. This trust can either pay out the required minimum distribution to the beneficiary or it can accumulate these distributions and pay out trust assets pursuant to the standards your clients set in advance (e.g., for higher education, to start a business, etc.)

Planning Tip:  Consider naming a stand-alone retirement trust as beneficiary of tax-qualified plans to ensure that the account passes not only in the manner intended by the client, but while achieving maximum stretch-out if that is the client’s objective.
Planning Tip:  Naming a trust as beneficiary also ensures consistent account management – in the manner desired by the client, using the client’s advisors – oftentimes over generations.

Give the Accounts to Charity at Death

Another relatively simple option is for your clients to name a charity as a designated beneficiary at their death or at the death of their survivor, if married. This strategy is particularly attractive for those clients who intend to make gifts to charity at death and the question is simply what assets should they select. As a tax exempt entity, a qualified charity does not pay income tax and therefore receives the full value of tax-qualified plans.

In other words, if the client’s beneficiary is in a 35% tax bracket, a $100,000 IRA is worth only $65,000 in his or her hands, but is worth the full $100,000 if given to charity. Therefore, it makes economic sense for clients to give these assets to charity and give to their beneficiaries assets that are not subject to income tax after death.

Planning Tip:  Naming a charity as beneficiary of a tax-qualified plan is particularly attractive for clients who intend to make gifts to charity at death and the question is simply what assets should they select.
Planning Tip:  By purchasing life insurance owned by a Wealth Replacement Trust, clients can give beneficiaries the full value of a tax-qualified plan in a manner that is free from income and estate tax, and protected from creditors and predators.

Take Lifetime Withdrawals, Buy an Immediate Annuity (plus Wealth Replacement Insurance)

Another option is for your clients to withdraw their IRA or qualified plan and purchase an immediate annuity, which will generate a guaranteed income stream during their lives (or during their joint lives if married). Your clients can use this income stream to pay the income tax caused by the withdrawal, and also pay the premiums on life insurance owned by a Wealth Replacement Trust.

This strategy makes the most sense if your clients are in good health and are able to obtain life insurance at reasonable rates. Unlike with an IRA or retirement plan, the beneficiaries will receive the life insurance proceeds from the Wealth Replacement Trust free of income and estate tax and, under certain circumstances, free of generation-skipping transfer tax.

Alternatively, it may make sense to use other assets to purchase the immediate annuity, saving the IRA for family members. This alternative strategy makes the most sense when your clients can name a very young beneficiary, thereby deferring the income tax on the IRA or qualified plan for many years.

Planning Tip:  For clients who desire a steady and known income stream, an annuity purchased with a lump-sum withdrawal from a tax-qualified plan can meet those objectives.
Planning Tip:  In many instances, the annuity income will provide additional cash flow sufficient to purchase life insurance that can replace or increase what would have passed to the beneficiaries.

Take Lifetime Withdrawals, Gift Remaining Cash through Life Insurance Trust

Another option for your clients is to take the money out during their lifetime and pay the income tax, then gift the remaining cash either outright via lifetime giving or, better yet, through an Irrevocable Life Insurance Trust. If your clients desire to make the gifts through an Irrevocable Life Insurance Trust, this strategy makes the most sense when they are in good health and able to obtain life insurance at reasonable rates. Unlike the IRA or retirement plan, the beneficiaries will receive the life insurance proceeds free of income and estate tax and, under certain circumstances, free of generation-skipping transfer tax.

Planning Tip:  By using withdrawals from a tax-qualified plan to purchase life insurance owned by a Wealth Replacement Trust, clients can pass the full value of the assets to their beneficiaries in a protected manner – undiminished by income tax.

Name a Charitable Remainder Trust as Beneficiary

Yet another option is for your clients to name as beneficiary of the accounts a Charitable Remainder Trust, a type of trust specifically authorized by the IRS. These irrevocable trusts permit your clients to transfer ownership of assets to the charitable trust in exchange for an income stream to the person or persons of their choice, typically the client’s spouse with tax-qualified plans. The term can be for life or for a specified term of up to 20 years.

The survivor receives income that will help maintain his or her lifestyle should the income stream from other assets be insufficient. At the survivor’s death, the property passes to charity.

This strategy defers income tax until the survivor receives each income payment; there is no tax at the initial transfer to the trust. This strategy can also help reduce estate taxes for those clients subject to the estate tax.

With this option, your clients fund the Charitable Remainder Trust upon death. Therefore, it is only at death or incompetency that this aspect of the estate plan becomes irrevocable, giving clients the option to make changes in the future if their circumstances change.

Planning Tip:  Naming a Charitable Remainder Trust as beneficiary of a tax-qualified plan can provide a steady income stream to a surviving spouse in a tax-deferred manner. Since the assets ultimately transfer to charity, this strategy also provides a charitable deduction for those clients subject to estate tax.

Give Up to $100,000 from IRAs Directly to Charity in 2007

For clients who are at least 70 1/2 years of age, it may also make sense for them to transfer up to $100,000 from IRAs to charity in 2007 to satisfy their charitable contributions. If the contribution is made by direct transfer from the IRA custodian to a public charity (for example, religious organizations, colleges and universities, etc.), the client need not report the distribution as taxable income. In other words, unlike a typical IRA distribution, the distribution will not appear as taxable income on the client’s income tax return. However, because the distribution does not appear as income, the client will not get an offsetting charitable income tax deduction to reduce the income created by the IRA distribution.

Planning Tip:  Giving up to $100,000 from IRAs directly to charity is particularly attractive for clients who intend to make gifts to charity in 2007 and the question is simply what assets should they select.


These are only a few of the more common planning solutions for tax-qualified plans. The right solution for your clients will depend upon their particular goals and objectives as well as their particular circumstances.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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Policy Reviews of Trust Owned Life Insurance: Why you should make it part of your standard estate planning process

Volume 2, Issue 3

This issue of our newsletter explores many of the common misperceptions about trust owned life insurance – plus a process for you to add significant value for your clients by incorporating policy reviews of trust owned life insurance.

Although trust owned life insurance (TOLI) is a common planning vehicle for high net worth individuals and families, relatively few TOLI policies ever meet their initial projections. Industry studies reveal that TOLI portfolios rarely receive the required vigilant fiduciary oversight routinely associated with other assets held in trust, such as equities, real estate, etc.

Seven Common Client Misconceptions – and Facts – about Life Insurance

Misconception #1: Unlike other assets, life insurance policies do not need management and regular review to avoid risk and optimize performance.
Fact: Policy performance can change dramatically over time. Without regular review by an insurance expert, policies – especially older ones – can pose very significant risk or not achieve their original goals.

Misconception #2: If the client pays premiums according to the schedule in the original insurance illustration, the policy will pay at death.
Fact: Even with regular payment of premiums projected from the original policy illustration, policies can fail if not monitored properly.

Misconception #3: If the policy was in jeopardy, the carrier would notify the client in advance.
Fact: Carriers will not necessarily provide advance notice of policy problems to trustee owners of TOLI policies.

Misconception #4: If one carrier has turned down the client for insurance, it is not possible to get adequate coverage from another carrier.
Fact: The competitive nature of the insurance industry means that it is often possible to secure appropriate coverage from a highly rated carrier even if another carrier has already rejected the client.

Misconception #5: Premiums will remain level for the life of the policy regardless of economic conditions or interest rates.
Fact: Premiums are always a reflection of the insurance carrier’s cost of providing coverage, current interest rates, and other economic conditions. Any of these changing factors can cause the premium rates to change.

Misconception #6: Policies purchased many years ago are cheaper than current policies because the insured is older.
Fact: Improved mortality rates as well as better underwriting and policy features created by industry competition often produce less expensive coverage on new policies (or increased coverage for the same premium).

Misconception #7: If the client no longer needs the insurance coverage provided by a policy, the only option is to surrender it to the carrier for relatively little value.
Fact: A variety of alternatives, including improved life settlement opportunities, make it possible to gain substantially greater value than that provided by cash surrender to the carrier.

What is a Trust Owned Life Insurance Review?

A TOLI review is an objective review of the policies owned by a trust to ensure that those policies perform as the client intended. A TOLI review also examines options for reducing premiums or selling policies that the client may no longer need because of changed circumstances, increased exemptions, etc.

Why should advisors tell their clients about TOLI review?

Advising your clients of a TOLI review will give immediate value during your interview. Few clients get excited about spending time or money on estate planning. By incorporating a “Life Insurance Policy Review,” the estate planning advisor can now create opportunities for immediate cash savings or profits for clients in addition to the standard planning and “projected estate tax savings at death.”

Planning Tip:  A TOLI policy review not only benefits the client, it also makes good business sense for the advisor. Such a review generates good will, gives the client a real appreciation of the advisor’s concern for the client, and frequently generates more than enough savings to pay for the advisor’s fees.

Why do the clients like the idea of a TOLI Review?

Nobody likes paying premiums and very few clients understand life insurance. When their advisor suggests an objective “audit” of insurance policies to determine if they could reduce their premiums, clients are receptive. They appreciate that you are trying to help them and that you are not selling them anything.

Why are trust companies rushing to implement TOLI Reviews?

Nearly every week banking journals publish articles on the fiduciary issues related to Trust Owned Life Insurance as institutional trust companies develop “best practices” to manage and monitor trust owned policies. Over 40% of institutionally trusteed policies reviewed have serious deficiencies or problems. Few institutional trustees have the necessary level of insurance expertise for proper policy review. Trust companies fear a lawsuit for improper management of their trust owned insurance policies.

Planning Tip:  Your clients need their advisors’ guidance to better understand both the risks and the improved opportunities from TOLI. The potential risk for your clients is substantial. Policy grantors and trustees need to recognize that life insurance is an asset that must be periodically reviewed by an independent expert to avoid risk and to optimize asset performance.

What are the results of reviewing Trust Owned Life Insurance policies?

Facts about TOLI policy reviews – there is a high likelihood that:

  1. The TOLI policy represents a considerable percentage of the client’s total estate.
  2. The TOLI policy has not been reviewed or managed since purchase.
  3. The TOLI policy is not performing as originally projected.
  4. The client must pay additional (unexpected) premiums before death.
  5. The client can get more insurance for the same premium (despite being older).
  6. The client can get the same insurance coverage for less premium outlay.
  7. The trustee has never reviewed the policy.
  8. The agent who sold the policy is no longer in touch with the client.
  9. The insurance coverage is no longer appropriate for the client.
  10. The policy provisions and guarantees are obsolete.
  11. The client and the trustee do not really understand the impact of falling interest rates since policy inception.
Planning Tip:  The average non-institutional trustee (for example, brother-in-law, friend, etc.) is even less informed than is an institutional trustee – and even less likely to audit policy performance. Therefore, the insurance risk is even greater with non-institutional trustees, but they may be less likely to act upon that risk.

What features are important in a reliable provider of TOLI review service?

  • Insurance expertise
  • Independence
  • Objective advice
Planning Tip:  Look for a turnkey TOLI review service that can offer not only an expert policy review and a clear comparison of all policy solutions, but also a cost-effective, comprehensive program to manage client policies.


Offering your clients an objective TOLI review provides them with significant value added and peace of mind as to their wealth planning; specifically, it increases the likelihood that their planning will achieve their stated objectives. Consider working with an advisor who can perform an objective TOLI review to accomplish this much needed – and often overlooked – analysis.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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10 Tips for Helping Families with Special Needs

Volume 2, Issue 2

This issue of our newsletter examines the unique planning requirements of families with children, grandchildren or other family members (such as parents) with special needs. There are many misconceptions in this area that result in costly mistakes in planning for special needs beneficiaries. There are many misconceptions in this area that result in costly mistakes in planning for special needs beneficiaries. It is, therefore, incumbent upon us – our clients’ advisors – to ensure that clients understand all of their options.

Costly Mistake #1: Disinheriting the special needs beneficiary.

Many disabled people rely on SSI, Medicaid or other government benefits to provide food and shelter. Your clients may have been advised to disinherit their special needs beneficiaries – beneficiaries who need their help most – to protect those beneficiaries’ public benefits. But these benefits rarely provide more than basic needs. And this “solution” does not allow your clients to help their special needs beneficiaries after the clients become incapacitated or are gone. When a loved one requires, or is likely to require, governmental assistance to meet his or her basic needs, parents, grandparents and others should consider establishing a Special Needs Trust.

Planning Tip:  It is unnecessary and in fact poor planning to disinherit special needs beneficiaries. Clients with special needs beneficiaries should consider a Special Needs Trust to protect public benefits and care for those beneficiaries during their own incapacity or after their death.

Costly Mistake #2: Procrastinating.

Because none of us knows when we may die or become incapacitated, it is important that your clients plan for a beneficiary with special needs early, just as they should for other dependents such as minor children. However, unlike most other beneficiaries, special needs beneficiaries may never be able to compensate for a failure to plan. Minor beneficiaries without special needs can obtain more resources as they reach adulthood and can work to meet essential needs, but special needs beneficiaries may never have that ability.

Planning Tip:  Parents, grandparents, or any other loved ones of a special needs beneficiary face unique planning challenges when it comes to that child. This is one area where clients simply cannot afford to wait to plan.

Costly Mistake #3: Failing to coordinate a planning team effort.

It is critical that advisors assisting with special needs planning include in the planning team: an attorney who is experienced in this planning area; a life insurance agent who can ensure that there will be enough money to maintain the benefits for the special needs child; a CPA who can advise on the Special Needs Trust’s tax return; an investment advisor who can help ensure that the trust fund’s resources will last for the special needs beneficiary’s lifetime; and any other key advisors that may support the goals of the trust going forward.

Planning Tip:  Special needs planning dictates that clients’ advisors work together to ensure that there are sufficient trust assets to care for special needs beneficiaries throughout their lifetime.

Costly Mistake #4: Ignoring the special needs when planning for a special needs beneficiary.

Planning that is not designed with the beneficiary’s special needs in mind will probably render the beneficiary ineligible for essential government benefits. A properly designed Special Needs Trust promotes the special needs person’s comfort and happiness without sacrificing eligibility.

Special needs can include medical and dental expenses, annual independent check-ups, necessary or desirable equipment (for example, a specially equipped van), training and education, insurance, transportation and essential dietary needs. If the trust is sufficiently funded, the disabled person can also receive spending money, electronic equipment & appliances, computers, vacations, movies, payments for a companion, and other self-esteem and quality-of-life enhancing expenses: the sorts of things your clients now provide to their child or other special needs beneficiary.

Planning Tip:  When planning for a beneficiary with special needs, it is critical that clients utilize a Special Needs Trust as the vehicle to pass assets to that beneficiary. Otherwise, those assets may disqualify the beneficiary from public benefits and may be available to repay the state for the assistance provided.

Costly Mistake #5: Creating a “generic” special needs trust that doesn’t fit.

Even some “special needs trusts”” are unnecessarily inflexible and generic. Although an attorney with some knowledge of the area can protect almost any trust from invalidating the beneficiary’s public benefits, many trusts are not customized to the particular beneficiary’s needs. Thus the beneficiary fails to receive the benefits that the parents or others provided when they were alive.

Another frequent mistake occurs when the Special Needs Trust includes a “pay-back” provision rather than allowing the remainder of the trust to go to others upon the death of the special needs beneficiary. While these “pay-back” provisions are necessary in certain types of special needs trusts, an attorney who knows the difference can save your clients hundreds of thousand of dollars, or more.

Planning Tip:  A Special Needs Trust should be customized to meet the unique circumstances of the special needs beneficiary and should be drafted by a lawyer familiar with this area of the law.

Costly Mistake #6: Failing to properly “fund” and maintain the plan.

When planning for a beneficiary with special needs, it is absolutely critical that there are sufficient assets available for the special needs beneficiary throughout his or her lifetime. In many instances, this requires utilization of a funding vehicle that can ensure liquidity when necessary. Oftentimes permanent life insurance is the perfect vehicle for this purpose, particularly for young and healthy clients while insurance rates are low.

Also, because this is an ever-changing area, it is imperative that clients revisit their plan frequently to ensure that it continues to meet the needs of the special needs beneficiary.

Planning Tip:  Clients should consider permanent life insurance as the funding vehicle for special needs beneficiaries, particularly with young beneficiaries given the often staggering costs anticipated over their lifetime.

For clients subject to estate tax, consider having an Irrevocable Life Insurance Trust own and be the beneficiary of the policy, naming the Special Needs Trust as a beneficiary. Alternatively, in a non-taxable situation, consider naming their revocable trust as the beneficiary to help equalize inheritances.

Costly Mistake #7: Choosing the wrong trustee.

Clients can manage the trust while alive and well. Once they are no longer able to serve as trustee, clients can choose who will serve according to the instructions they provide. Clients may choose a team of advisors and/or a professional trustee. Whomever they choose, it is crucial that the trustee is financially savvy, well-organized and of course, ethical.

Planning Tip:  The trustee of a Special Needs Trust should understand the client objectives and be qualified to invest the assets in a manner most likely to meet those objectives.

Costly Mistake #8: Failing to invite contributions from others to the trust.

A key benefit of creating a Special Needs Trust now is that the beneficiary’s extended family and friends can make gifts to the trust or remember the trust as they plan their own estates. For example, these family members and friends can name the Special Needs Trust as the beneficiary of their own assets in their revocable trust or will, and they can also name the Special Needs Trust as a beneficiary of life insurance or retirement benefits.

Planning Tip:  Creating a Special Needs Trust now allows others, such as grandparents and other family members, to name the trust as the beneficiary of their own estate planning.

Costly Mistake #9: Relying on siblings to use their money for the benefit of a special needs child.

Many clients rely on their other children to provide, from their own inheritances, for a child with special needs. This can be a temporary solution for a brief time, such as during a brief incapacity if their other children are financially secure and have money to spare. However, it is not a solution that will protect a child with special needs after your clients have died or when siblings have their own expenses and financial priorities.

What if an inheriting sibling divorces or loses a lawsuit? His or her spouse (or a judgment creditor) may be entitled to half of it and will likely not care for the child with special needs. What if the sibling dies or becomes incapacitated while the child with special needs is still living? Will his or her heirs care for the child with special needs as thoughtfully and completely as the sibling did?

Siblings of a child with special needs often feel a great responsibility for that child and have felt so all of their lives. When clients provide clear instructions and a helpful structure, they lessen the burden on all their children and support a loving and involved relationship among them.

Planning Tip:  Relying on siblings to care for a special needs beneficiary is a short-term solution at best. A Special Needs Trust ensures that the assets are available for the special needs beneficiary (and not the former spouse or judgment creditor of a sibling) in a manner intended by the client.

Costly Mistake #10: Failing to protect the special needs beneficiary from predators.

An inheritance that funds a special needs trust by will rather than by revocable living trust is in the public record. Predators are particularly attracted to vulnerable beneficiaries, such as the young and those with limited self-protective capacities. By planning with trusts rather than a will, clients decide who has access to the information about the transfer of their property. This protects their special needs child and other family members, who may be serving as trustees, from predators.

Planning Tip:  A Special Needs Trust created outside of a will ensures that information about the inheritance is not in the public record, protecting the special needs beneficiary from predators.


Planning for special needs beneficiaries requires particular care and the participation of all of the clients’ wealth planning advisors. A properly drafted and funded Special Needs Trust can ensure that special needs beneficiaries have sufficient assets to care for them, in a manner intended by their loved ones, throughout the beneficiaries’ lifetime.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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The Continuing Need for Life Insurance

Volume 2, Issue 1

The last issue of our newsletter examined the various educational savings vehicles available to clients, including 529 plans, UGMA/UTMAs, Coverdell Education IRAs and life insurance. Using life insurance as an education savings vehicle prompted several questions about other uses for life insurance. Therefore, this issue of the Wealth Counselor examines some of these other common uses for life insurance, the only asset class that can ensure the completion of proper funding for a myriad of unique planning needs – regardless of the state of the federal estate tax!

Income Replacement
How will my family eat if I die?

Even if the client is not subject to estate tax, life insurance can replace lost income if the client dies unexpectedly (more policies pay out for income replacement than for liquidity to pay estate tax). For example, clients with young children should consider using life insurance to ensure that there are sufficient funds available to pay for child-rearing or college and post-graduate expenses in the event of a parent’s premature death. For these income replacement policies, the estate tax, including the possibility of estate tax repeal, has no significance.

Planning Tip:  Clients should consider life insurance to replace income from the premature death of a breadwinner spouse or parent.

Wealth Creation
What if I die before I build an estate for my family?

Another need for life insurance unaffected by the estate tax is the use of life insurance to create wealth. Examples of this need are families who wish to add to their wealth for future generations or to fund their philanthropic objectives.

Planning Tip:  Consider life insurance to create wealth or additional wealth for the client’s family and future generations.

Wealth Replacement
How can my family receive the full value of my assets?

Traditionally, life insurance has been used to replace wealth lost to the federal estate tax. However, with an increasing federal estate tax exemption (currently $2 million per individual, $4 million per married couple), fewer clients are subject to federal estate tax. Thus, fewer clients need traditional wealth replacement policies. However, many clients have significant other wealth replacement needs.

For example, many clients’ most significant assets are tax-qualified plans (such as IRAs, 401(k)s and pension plans). Because these assets are Income in Respect of a Decedent (IRD), they will be subject to ordinary income tax when distributed to beneficiaries. While we often discuss with clients maximum income tax deferral (“stretch out”), many beneficiaries will deplete these assets quickly, incurring significant income tax. Recognizing this, many clients would benefit from life insurance designed to replace this lost wealth.

In addition to traditional wealth replacement needs, wealthier clients would benefit from wealth replacement for assets transferred to a charitable remainder trust (CRT) or to a charitable lead trust (CLT), which is often used to eliminate estate tax.

Planning Tip:  Consider life insurance for non-traditional wealth replacement purposes, such as to replace income tax paid for significant IRAs and other tax-qualified plans, or where the client has used a charitable lead trust to avoid estate tax.

Planning Unrelated to the Federal Estate Tax
I didn’t know there were so many other situations where only life insurance will assure me my goals will be reached even if I die!

Clients often use life insurance in planning that is wholly unrelated to the estate tax. There is a continuing need for life insurance as a funding vehicle in numerous situations, including:

  • buy-sell planning;
  • key employee coverage;
  • nonqualified deferred compensation;
  • death-benefit-only plans;
  • liquidity to pay debts;
  • liquidity for state death taxes; and
  • inheritance equalization.

Income-Tax-Free Status of Death Benefits
What a difference not paying taxes can make on the amount to which my premiums can grow.

With increasing federal estate tax exemption amounts, there is now an increased emphasis on income tax planning, with a particular emphasis on assets that combine basis step-up with tax-free or tax-deferred growth. Life insurance proceeds paid upon the death of the insured, as well as proceeds attributable to investment appreciation on the cash value portion of the policy, are excluded from gross income. As a result, not only is the death benefit of a life insurance policy tremendous compared to the premiums paid if the insured dies prematurely, in a properly designed policy the death benefit remains quite handsome even if the insured lives past life expectancy.

Planning Tip:  The unique character of life insurance allows a capable and competent life insurance agent to design a product providing excellent results over a long time frame.

Irrevocable Life Insurance Trusts
A little planning can provide enormous tax savings.

Even though the insurance death benefit is not subject to income tax, the life insurance proceeds will likely be included in the client’s gross estate and, therefore, be subject to federal and/or state estate tax absent a properly drafted and maintained Irrevocable Life Insurance Trust (ILIT). As a result, many clients create ILITs for the purpose of owning life insurance to avoid federal and state estate tax on the death proceeds.

Planning Tip:  Use an Irrevocable Life Insurance Trust to purchase, own and be the beneficiary of life insurance to avoid having the death proceeds subject to estate tax. A good lawyer with prompt turnaround of a trust document is a critical component of the planning team.

Planning Flexibility
How can I deal with the uncertainty of estate taxes?
Will I need the extra cash at my death, or not?

The uncertainty surrounding the federal estate tax and the exemption equivalent amount may suggest the use of the most flexible types of cash value policies, such as universal life policies. These policies permit the policy owner to vary the amount of premium payment, the level of death benefit, and the amount of cash value (in exchange for this flexibility, the client may give up the guarantees that the premium will provide a guaranteed death benefit for the life of the policy). No other single asset provides the same degree of planning flexibility. However, it is incumbent on the planning professional to ensure that the product selected fits the needs of the particular client.

Planning Tip:  Permanent life insurance is a unique asset that provides the highest degree of flexibility for changes in the law or changes in the client’s circumstances. The quality of the life insurance agent and the life insurance company he or she selects are among the most important choices a client can make.


Life insurance is the only asset class (other than cash) that a client can remove from his or her gross estate, yet it still provides liquidity (e.g., for federal or state death tax or capital gain tax) or wealth replacement (e.g., to make beneficiaries “whole” for large IRD items like IRAs, 401(k)s, and pension plans) without itself incurring income tax. All other assets removed from the client’s gross estate for estate tax purposes must be sold and the gain realized to net the required amount.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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Understanding Educational Savings Vehicles

Volume 1, Issue 3

The last issue of our newsletter examined the many benefits of 529 Plans, including the income tax and gift and estate tax benefits of these popular educational savings vehicles. There are, however, several other educational savings vehicles that clients should consider; this issue examines some of these other vehicles – and the advantages and disadvantages of each.

Why is saving for education so important?According to the College Board, the average cost of a four-year college or university is increasing at two to three times the rate of inflation. For the 2006-2007 school year, costs average $5,836 per year for an in-state four-year college and $22,218 per year at a private four-year college. Therefore it is no surprise that advisors who understand the options bring significant value to their clients.

Planning Tip:  Saving for college is often the most significant savings goal for adults facing college costs in the future.

UGMA/UTMA Accounts

The simplest form of education savings vehicles, and perhaps the most common, is an account created under the Uniform Gift to Minors Act (UGMA) or, its successor, the Uniform Transfer to Minors Act (UTMA) in the child’s state. While simple and inexpensive, there are considerable disadvantages to UGMA and UTMA accounts.

Most clients’ biggest concern with these accounts is that a gift made to an UGMA or UTMA account vests absolutely in the beneficiary. In other words, neither the custodian nor the donor can change the beneficiary after establishment of the account, and, significantly, the custodian must deliver the balance of the account outright to the beneficiary when he or she reaches the age of majority (18 or 21, as defined by state law). For a beneficiary receiving government benefits, this required outright distribution may cause the beneficiary to lose his or her government assistance upon attainment of majority. Until the beneficiary reaches majority, the custodian has a fiduciary duty to spend the income or principal for the benefit of the minor.

Planning Tip:  UGMA and UTMA accounts are the simplest education savings vehicles, but upon attaining the age of majority, the beneficiary has the absolute right to the account and can spend it as he or she pleases, not limited to education.

Effective May 17, 2006, the “kiddie tax” may also come into play for beneficiaries who are younger than 18 (it previously applied only to beneficiaries younger than 14). With the kiddie tax, if the parents claim as a dependent a child under age 18, all of that child’s unearned income above $1,700 per year (for 2006), including UGMA or UTMA income, will be taxed at the parent’s income tax rate, whether or not the parent is the custodian. For children 18 years and older, the income on assets in a UGMA or UTMA account is generally taxed at the child’s rate, typically much lower than the parents’ rate.

Planning Tip:  The “kiddie tax” applies to UGMA and UTMA accounts if the beneficiary is under 18 and has unearned income greater than $1,700 in 2006. If so, the beneficiary child must complete and attach IRS Form 8615 to his or her income tax return and pay this tax at the parents’ income tax rate.

While a transfer to a minor under UGMA or UTMA constitutes a completed gift for federal gift tax purposes at the time of the transfer, if the donor names himself or herself as custodian of the account and that person dies before the child reaches majority, the UGMA or UTMA account assets will be includible in the donor/custodian’s gross estate for estate tax purposes.

Planning Tip:  A donor should not name himself or herself as custodian of the UGMA or UTMA account to avoid the account assets from being included in the donor’s estate for federal estate tax purposes.

Coverdell Education Savings Accounts (ESAs)

Education Savings Accounts, formerly Education IRAs, were of little significance until passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA increased the maximum annual contribution limit from $500 to $2,000 per beneficiary, while also increasing the AGI limits for maximum contributions to these accounts. Significantly, as a result of EGTRRA, a donor can make contributions to an ESA and a College Savings Plan for the same child in the same year. Moreover, while 529 Plans are limited to paying for higher education, ESAs can be used to fund primary and secondary school.

Planning Tip:  Clients should consider contributions to both 529 plans and Education Savings Accounts for the same beneficiary in the same year, to cover educational expenses of primary through higher education.

Life Insurance

The inside cash buildup of permanent life insurance policies such as whole life, universal life, and variable life offer another opportunity to accumulate funds that can be used for educational expenses. This strategy usually makes sense when the client has an already existing need for life insurance (such as protecting a family’s income in case of death). A very simplified explanation of this technique is for the client to pay into the life insurance policy more than is needed to support the policy through the life of the client. These extra funds accumulate inside the life insurance policy on an income tax free basis and can be accessed by the client when his or her children reach college age (or if there is an emergency or other need).

Flexible premium universal life and variable universal life policies typically include the option to take partial withdrawals from, or loans against, the cash value of the policy (some policies even have a “wash” loan feature that makes loans even more attractive). When the time comes, the client will either withdraw or borrow the necessary college funding from the accumulated cash value of the life policy.

Withdrawals from a cash value life insurance policy (other than a modified endowment contract) are not subject to income tax until the cumulative withdrawals exceed the cost basis, or the aggregate premium payments on the policy. Loans from such policies are likewise not taxable at the time of the loan nor are they taxable if they are repaid from the death benefits when the policy “matures.”

Careful planning is needed to determine the premium structure, the best method to access the cash buildup in the life insurance policy, and to make sure the viability of the policy is not endangered. Usually making withdrawals to basis first and then borrowing from the cash value is the preferred method to access the cash value of a policy having any loans repaid at death from the income tax free proceeds of the life policy.

An added benefit of this technique is that if the client dies prematurely the death benefit from the life policy becomes available to pay for college or other family expenses.

As with most sophisticated planning, there may be traps for the unwary. For example, there can be very negative tax effects if the plan is not designed properly or the policy doesn’t perform as expected and there isn’t an adequate cushion so that the life policy lapses before death. And of course there are estate tax considerations to be taken into account. That said, in the hands of an experienced life insurance professional, this technique can be quite beneficial and allow for several potential needs to be met with one planning device.

Planning Tip:  Clients should consult a knowledgeable and experienced life insurance professional and tax counsel when considering the use of permanent insurance to fund higher education or provide additional cash benefits in the event of a bread winner parent’s premature death.

Demand Trusts

Demand rights convert what would otherwise be a gift of a future interest to a gift of a present interest, thereby qualifying the gift for the $12,000 gift tax annual exclusion. To qualify, the trustee must adhere to the strict procedure requirements for Crummey trusts: the trustee must immediately notify the minor beneficiary through the child’s legal guardian that the donor has made a gift to the trust. The beneficiary then has a specified period of time (typically 30 days) to demand a distribution from the trust in the amount of the gift. If the specified number of days lapses, the gift will stay inside the trust and continue to be governed by the trust terms.

This demand right allows the trust maker to make contributions of up to $12,000 per year, free of gift tax and possibly generation-skipping transfer (GST) tax.

Demand trusts remove the trust assets from the trust maker’s estate, even if the trust maker acts as trustee, as long as the trust instrument limits the trustee’s discretion to make distributions to “ascertainable standards”; i.e., the education, health, maintenance and support of the beneficiary (and provided the trust instrument does not give the trust maker too much control over the trust). If a demand right beneficiary dies during the time that a demand right is outstanding, the amount of the outstanding demand right is includible in the beneficiary’s gross estate for estate tax purposes.

Planning Tip:  Demand trusts are a flexible savings vehicle for education expenses and other expenses set forth by the trust maker in the trust agreement. While typically funded with life insurance, the trust maker can also fund a demand trust with other assets.

Direct Payments to an Educational Institution Another educational funding option is for the donor to make transfers directly to an educational institution. Under the Internal Revenue Code, these transfers are not subject to gift, estate, or GST tax. Therefore, prepaid tuition payments by a donor can achieve a significant estate tax reduction. Direct payments are not deductible as a charitable contribution for income tax purposes, however, because they are made for a particular student.

Since only direct payments to the educational institution qualify, it is highly recommended that the donor make contributions to the school while the child is presently enrolled. If the donor wishes to make advance payments for numerous years’ tuition, the donor (and the parent(s) if the donor is the student’s grandparent) should enter into a written agreement with the educational institution providing that (1) the donor and/or parent will pay any future tuition increases; (2) the prepayments are non-refundable; and (3) the prepayment does not afford the child any additional rights or privileges over any other student.

Impact on Financial Aid

For some clients, the impact on needs-based financial aid may play a role in the selection process, because assets placed in the student’s name may reduce (or even eliminate) the amount of otherwise available financial aid. The needs based financial aid rules state that 5% of the parent’s assets (special rules determine this amount for financial aid purposes) and 35% of the child’s assets are available for education. Therefore, shifting assets from the parent to the student through the use of UGMA/UTMAs, ESAs, and 529 plan distributions may reduce the student’s needs based financial aid. Alternatively, life insurance should not impact needs based aid, whereas a demand trust will depend upon the child’s access through the trust terms.

Planning Tip:  Avoid shifting assets to the child if the client is concerned about the potential impact on needs based financial aid.


There are numerous education savings options. Most often, the “right” choice for the client will depend upon his or her unique goals and objectives. It is therefore incumbent upon all wealth planning professionals to help the client determine those objectives and advise accordingly.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

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