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New Planning Opportunities with Non-Spouse Rollovers

Volume 2, Issue 11

Before 2007, a non-spouse beneficiary of a qualified plan was stuck taking distributions under the terms of the plan, which typically required full distribution within five or fewer years of the participant’s death. The Pension Protection Act of 2006 (PPA 2006) authorized non-spouse beneficiaries (before it was only surviving spouses) to roll over to an Inherited IRA.

This issue of our newsletter looks at a very recent pronouncement from the IRS that finally makes this PPA 2006 provision useable and, therefore, is very beneficial to clients and all wealth planning professionals who understand its implications.

Apparent Good News in PPA 2006

PPA 2006 provides that, effective January 1, 2007, a non-spouse qualified plan beneficiary may be permitted to roll over to an Inherited IRA after the plan participant’s death.

The January 2007 IRS Roadblock

Unfortunately, the IRS focused on the “may” and quickly issued guidance that virtually eliminated the planning opportunity that PPA 2006 seemed to provide. In its January 29, 2007 Notice 2007-7, the IRS declared that a plan was not required to offer non-spouse rollovers, saying it was optional with the plan provider whether to adopt a plan amendment permitting non-spouse rollovers. Therefore, absent a voluntary plan amendment, a non-spouse was stuck using the plan’s payout period. And major plan providers did not offer such amendments to their prototype plans.

The October 2007 IRS Roadblock Removal In late October the IRS issued its 2007 Interim and Discretionary Amendments, as follows:

“Section 402(c)(11) [Discretionary]: PPA ’06 . . . added Section 402(c)(11) to allow nonspouse beneficiaries to roll over distributions from a qualified plan to an individual retirement plan. Nonspouse beneficiary rollovers are an optional plan provision for 2007. See, Notice 2007-7. Pursuant to an impending technical correction, nonspouse beneficiary rollovers will be required for plan years beginning on or after January 1, 2008.” (Emphasis added.)

This amendment appears to be in anticipation of a Congressional change to PPA 2006 to make it mandatory that qualified plans permit non-spouse rollovers. The full text of the IRS document is at www.irs.gov/retirement/article/0,,id=173372,00.html.

What Does All This Mean for Your Clients?

Beginning January 1, 2008, non-spouse beneficiaries finally will be able to take advantage of the PPA 2006 provisions and roll over from a qualified plan into an Inherited IRA. In the Inherited IRA, the non-spouse beneficiary can use his or her own life expectancy to determine annual required minimum distributions (RMDs). This can significantly reduce the amount that the beneficiary must withdraw each year, thereby deferring income tax and allowing the account balance to continue to grow income tax free.

Implementation of a non-spouse rollover raises numerous pitfalls for the unwary. These pitfalls are identified in the Planning Tips that follow.

Planning Tip:  The transfer must be DIRECTLY from the plan Trustee to the Inherited IRA’s Custodian or Trustee.
Planning Tip:  Any distribution to a non-spouse beneficiary is a taxable distribution, subject to income tax. Therefore any check delivered by the plan Trustee MUST be made payable directly to the Inherited IRA Custodian or Trustee.
Planning Tip:  Unlike with a surviving spouse rollover, the Inherited IRA must remain in the name of the deceased participant. The Inherited IRA should be titled like this: Account Holder, deceased, IRA f/b/o Beneficiary.
Planning Tip:  DO NOT re-title the qualified plan in the name of the non-spouse beneficiary. That will be treated as a taxable distribution.
Planning Tip:  DO NOT transfer from the qualified plan to an existing IRA in the non-spouse beneficiary’s name. That, too, constitutes a taxable distribution of the entire account.
Planning Tip:  A non-spouse beneficiary must begin taking required minimum distributions from the Inherited IRA by December 31 of the year following the year of the participant’s death. Note: This is different from a spouse rollover, where the surviving spouse can defer required minimum distributions until attaining age 70 1/2.

Planning Opportunities

The IRS’s change of position means that additional planning options are now available for non-spouse beneficiaries of qualified plans. These options include those listed below, which were outlined in greater detail in a prior issue of The Wealth Counselor:

  • Name a Retirement Trust as beneficiary to ensure the longest term payout possible, while also ensuring 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 and replace with insurance owned by a Wealth Replacement Trust.
  • Take the money out during lifetime and buy an immediate annuity to provide a guaranteed annual income, to pay the income tax, and to pay for Insurance owned by a Wealth Replacement Trust.
  • Take the money out during lifetime and pay the income tax, then gift the remaining cash through an Irrevocable Life Insurance Trust or other Irrevocable Trust.
  • Name a Charitable Remainder Trust as beneficiary with a lifetime payout to a surviving spouse; the remaining assets passing to charity at the death of the spouse.
  • Give up to $100,000 from IRAs directly to charity before December 31, 2007.

Asset Management Opportunities

Experience teaches that beneficiaries often frustrate the stretch-out plans of the decedent and squander their opportunity for tax-free growth by withdrawing far more than the required minimum distributions. However, if the participant names a trust as beneficiary of the qualified plan, PPA 2006 provides that the trustee of that trust may roll over from the qualified plan into an Inherited IRA for the benefit of the trust beneficiary. Clients who name a trust as beneficiary of their qualified plan account can thereby protect the assets from creditors (including loss in a beneficiary’s divorce) and the beneficiary from the temptation to be a spendthrift.

Planning Tip:  Naming a trust as beneficiary also allows the participant’s trusted financial advisor to continue to manage assets as the participant desired.


The IRS now requires that all qualified plans permit non-spouse rollovers for plan years beginning on or after January 1, 2008. This “about face” means that all non-spouse beneficiaries will be able to roll over from qualified plans to Inherited IRAs rather than be stuck with shorter payout under the plan provisions. This will permit the planning team to implement the right strategy to meet the client’s unique planning objectives.

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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Simplifying the Taxation of Trusts

Volume 2, Issue 10

The last issue of our newsletter examined trusts and the asset protection benefits provided to trust makers and their beneficiaries through the utilization of ongoing trusts. This issue of our newsletter addresses related and important questions about the taxation of trusts, which are important to all wealth planning professionals.

Trusts are Separate Taxpayers

All trusts are separate taxpayers. Unless disregarded under the exception for grantor trusts discussed below, each trust has its own tax year and tax accounting method. Trusts also receive income and pay expenses. Net income is taxed either to the trust or to the beneficiaries, depending upon the trust terms, local law and, in the cases of complex trusts (defined below), whether the trust distributed the income.

Planning Tip:  If a trust permits accumulation of income and the trust does not distribute it, the trust pays tax on the income.
Planning Tip:  If a trust distributes or is deemed to have distributed the income to the beneficiaries, the trust can deduct the amount of the distribution and the beneficiaries must include it as income.

A trust’s distributable net income (DNI) determines the amount of the distribution the trust can deduct, and the amount the beneficiary must report as income. Thus, DNI acts as a ceiling on the amount of the deduction a trust can take for distributions to beneficiaries. DNI also acts as a ceiling on the amount of the distribution that the beneficiary must account for on his or her income tax return.

Planning Tip:  As a general rule, distributions from a trust are first taken from DNI, then from principal.

An explanation of the DNI calculation is beyond the scope of this newsletter. However, it is important to note that this is an area where the client’s wealth planning team must work together to ensure that the income taxation flows as the client desires. For example, as a general rule, capital gains will be subject to taxation at the trust level except in the year the trust terminates. However, if the client so desires and if it is permissible under state law, the lawyer can draft the trust agreement so that it defines trust income to include capital gains, thereby passing the capital gains tax liability to the beneficiary.

Planning Tip:  It is critical that the client’s wealth planning team work together to ensure that trust income will be subject to taxation as the client desires.

Simple vs. Complex Trusts

The Internal Revenue Code defines a simple trust as a trust that:

  1. By its terms must distribute all of its income (meaning fiduciary accounting income) currently;
  2. Makes no principal distributions; and
  3. Makes no distributions to charity.

The regulations to the Internal Revenue Code define a complex trust as a trust that is not a simple trust; in other words, a trust that:

  1. Is allowed by its terms to accumulate income;
  2. Makes discretionary distributions of income or mandatory or discretionary distributions of principal; or
  3. Makes distributions to charity.

Grantor Trusts

The Internal Revenue Code defines a grantor trust as a trust in which the trust maker has one or more of the powers specifically described in Sections 673 to 677. A trust can also be a grantor trust as to a beneficiary where the beneficiary has one or more of these same powers if the beneficiary also has or had the power over the trust principal described in Section 678. To the extent a trust is a grantor trust, it functions as a conduit; in other words, all of the income, deductions, credits, etc., flow through to the trust maker or beneficiary and are subject to tax on their own personal tax return, regardless of whether the trustee makes distributions from the trust. The general rules governing the income taxation of trusts and their beneficiaries do not apply to grantor trusts due to application of these rules.

Planning Tip:  Revocable trusts are grantor trusts as to their trust maker(s) and thus a revocable trust’s income and deductions flow through to its trust maker(s).
Planning Tip:  Grantor trusts are powerful planning tools because of the fact that the trust is the same as the grantor for income tax purposes. Thus, a sale by a grantor to a grantor trust does not trigger income tax.

It is now clear that with a grantor trust, the grantor’s payment of the trust income tax does not constitute a gift to the trust beneficiaries. Thus, for those clients who are willing to pay this tax, grantor trusts are also excellent vehicles to leverage gifts to beneficiaries.

Planning Tip:  By paying the income tax of a grantor trust, the grantor is in essence making an additional contribution to the trust, but one that is not subject to gift tax.

Grantor Trusts and Life Insurance

Grantor trusts also can be very useful in the context of transfers of life insurance. When transferring life insurance (for example, from the insured to avoid estate tax inclusion or to a “new” irrevocable life insurance trust), consider selling the policy for full and adequate consideration to a trust that is a grantor trust as to the insured. As long as the sale is for the policy’s full fair market value, such a transfer will avoid the three-year estate tax inclusion rule, and it will not invoke the transfer-for value rules.

Planning Tip:  A sale of life insurance to a grantor trust for full and adequate consideration avoids both the three-year estate inclusion rule for transfers of ownership and the transfer-for value rule.

Compressed Income Tax Brackets for Trusts

A frequent objection to the accumulation of trust income is the fact that trusts pay federal income tax according to a compressed rate schedule. In other words, trusts pay the maximum federal income tax rate of 35% at only approximately $10,500 of income per year in 2007, compared to approximately $350,000 for single taxpayers, heads of household, or those married filing jointly.

On its face, it appears that it may be costly from an income tax perspective to accumulate trust income. However, the critical questions are, what type of income is it and, if interest or rent income, will accumulation result in additional tax? In other words, what are the relative tax rates of the beneficiaries?

Planning Tip:  The compressed tax rates for trusts only apply to accumulated interest and rent income. Trusts pay the same rates as individuals for capital gains and dividend income. Thus, careful investment of trust assets can reduce or eliminate the impact of compressed tax rates.
Planning Tip:  If the trust beneficiaries are already in the maximum federal income tax bracket, accumulation of interest income will not cause additional tax. In fact, with these beneficiaries, accumulation of trust income may actually reduce their overall income tax by not phasing out deductions and credits.
Planning Tip:  If the trust beneficiaries are not in the maximum federal income tax bracket, what are their relative tax brackets? The tax impact of income accumulation is the difference in the tax rates, likely an additional 7% or less, not the full 35%.

Furthermore, trust makers can give a trustee the ability not only to distribute directly to a beneficiary (which is not good for asset protection), but also the discretion to make distributions on behalf of a beneficiary such as to pay rent, medical expenses, tuition, credit card bills, etc.

Planning Tip:  Distributions on behalf of a beneficiary are distributions to the beneficiary for tax purposes and will be subject to tax at the beneficiary’s rates. Such distributions are also good for asset protection because the trustee does not make them directly to the beneficiary. Thus, to the extent the trustee is able to “distribute” to pay for these needs directly, trust income will be taxed at the beneficiary’s income tax rate.


A working knowledge of the taxation of trust income is important for the client’s entire wealth planning team. By working together, the team can often minimize the overall tax impact and help ensure that our plan meets the client’s unique planning objectives.

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 the Significance of Trusts

Volume 2, Issue 9

This issue of our newsletter addresses a topic that is important to clients and all wealth planning professionals – trusts. When used properly, trusts can provide significant advantages to clients and to the advisors who recommend them. Given the numerous types of trusts, this newsletter explores the general advantages of trusts as well as some of the most common types of trusts.

Revocable vs. Irrevocable Trusts

There are two basic types of trusts: revocable trusts and irrevocable trusts. Perhaps the most common type of trust is revocable trusts (aka revocable living trusts, inter vivos trusts or living trusts). As their name implies, revocable trusts are fully revocable at the request of the trust maker. Thus, assets transferred (or “funded”) to a revocable trust remain within the control of the trust maker; the trust maker (or trust makers if it is a joint revocable trust) can simply revoke the trust and have the assets returned. Alternatively, irrevocable trusts, as their name implies, are not revocable by the trust maker(s).

Revocable Living Trusts

As is discussed more below, revocable trusts do not provide asset protection for the trust maker(s). However, revocable trusts can be advantageous to the extent the trust maker(s) transfer property to the trust during lifetime.

Planning Tip:  Revocable trusts can be excellent vehicles for disability planning, privacy, and probate avoidance. However, a revocable trust controls only that property affirmatively transferred to the trust. Absent such transfer, the revocable trust may not control disposition of the trust maker’s property.
Planning Tip:  Unlike with a trust, one cannot affirmatively transfer title of property during life using a will. Also, whether estate planning is by will or trust, it is important to ensure that the client’s property passing pursuant to contract (e.g., by beneficiary designation for retirement plans and life insurance) does not thwart the client’s planning objectives set forth in the trust or will.

Asset Protection for the Trust Maker

The goal of asset protection planning is to insulate the client’s assets that would otherwise be subject to the claims of his or her creditors. Typically, a creditor can reach any assets owned by a debtor. Conversely, a creditor cannot reach assets not owned by the debtor. This is where trusts come into play.

Planning Tip:  The right types of trusts can insulate assets from creditors because the trust owns the assets, not the debtor.

As a general rule, if a trust maker creates an irrevocable trust and is a beneficiary of the trust (i.e., it is a so-called self-settled spendthrift trust), assets transferred to the trust are not protected from the trust maker’s creditors. This general rule applies whether or not the transfer was done to defraud a creditor or creditors.

Until fairly recently, the only way to remain a beneficiary of a trust and get protection against creditors for the trust assets was to establish the trust outside the United States in a favorable jurisdiction. This can be an expensive proposition.

However, the laws of a handful of states (including Alaska, Delaware, Nevada, Rhode Island, South Dakota, and Utah) now permit self-settled spendthrift trusts or what are commonly known as domestic asset protection trusts. Under the laws of these few states, a trust maker can transfer assets to an irrevocable trust and the trust maker can be a trust beneficiary, yet trust assets can be protected from the trust maker’s creditors to the extent distributions can only be made within the discretion of an independent trustee. Note that this will not work when the transfer was done to defraud or hinder a creditor or creditors. In that case, the trust will not protect the assets from those creditors.

Planning Tip:  A handful of states permit self-settled spendthrift trusts or what are commonly known as domestic asset protection trusts.

For those clients unwilling to give up a beneficial interest in their assets to protect those assets from future creditors, trusts established under the laws of a jurisdiction that permits self-settled spendthrift trusts or a trust established under the laws of a foreign country, may be appealing.

Asset Protection for Trust Beneficiaries

A revocable trust provides no asset protection for the trust maker during his or her life. Upon the death of the trust maker, however, or upon the death of the first spouse to die if it is a joint trust, the trust becomes irrevocable as to the deceased trust maker’s property and can provide asset protection for the beneficiaries, with two important caveats.

First, the assets must remain in the trust to provide ongoing asset protection. In other words, once the trustee distributes the assets to a beneficiary, those assets are no longer protected and can be attached by that beneficiary’s creditors. If the beneficiary is married, the distributed assets may also be subject to the spouse’s creditor(s), or they may be available to the former spouse upon divorce.

Planning Tip:  Consider trusts for the lifetime of the beneficiaries to provide prolonged asset protection for the trust assets. Lifetime trusts also permit the client’s financial advisor to continue to invest the trust assets as the client desired, which also helps ensure that trust returns are sufficient to meet the client’s planning objectives.

The second caveat follows logically from the first: the more rights the beneficiary has with respect to trust distributions, the less asset protection the trust provides. Generally, a creditor “steps into the shoes” of the debtor and can exercise any rights of the debtor. Thus, if a beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a distribution from that trust.

Planning Tip:  The more rights a beneficiary has to compel distributions from a trust, the less protection that trust provides for that beneficiary.

Therefore, where asset protection is a significant concern for the client, it is important that the trust maker not give the beneficiary the right to automatic distributions (for example, 5% or $5,000 annually). A creditor will simply salivate in anticipation of each distribution. Instead, the client should consider discretionary distributions by an independent trustee.

Planning Tip:  Consider a professional fiduciary to make distributions from an asset protection trust. Trusts that give beneficiaries no distribution rights, but rather give complete discretion to an independent trustee, provide the highest degree of asset protection.

Lastly, with divorce rates at or exceeding 50% nationally, the likelihood of a client’s child becoming divorced is quite high. By keeping assets in trust, the trust maker can ensure that the trust assets do not go to a former son-in-law or daughter-in-law, or their bloodline.

Irrevocable Life Insurance Trusts

With the exception of the self-settled spendthrift trusts discussed above, a transfer to an irrevocable trust can protect the assets from creditors only if the trust maker is not a beneficiary of the trust. One of the most common types of irrevocable trust is the irrevocable life insurance trust, also known as a Wealth Replacement Trust.

Under the laws of many states, creditors can access the cash value of life insurance. But even if state law protects the cash value from creditors, at death, the death proceeds of life insurance owned by your clients are includible in their gross estate for estate tax purposes. Clients can avoid both of these adverse results by having an irrevocable life insurance trust own the insurance policy and also be its beneficiary. The dispositive provisions of this trust typically mirror the provisions of the client’s revocable living trust or will. And while this trust is irrevocable, as with any irrevocable trust, the trust terms can grant an independent trust protector significant flexibility to modify the terms of the trust to account for unanticipated future developments.

Planning Tip:  In addition to providing asset protection for the insurance or other assets held in trust, irrevocable life insurance trusts can eliminate estate tax and protect beneficiaries in the event of divorce.

If the trust maker is concerned about accessing the cash value of the insurance during lifetime, the trust can give the trustee the power to make loans to the trust maker during lifetime or the power to make distributions to the trust maker’s spouse during the spouse’s lifetime. Even with these provisions, the life insurance proceeds will not be included in the trust maker’s estate for estate tax purposes.

Planning Tip:  With a properly drafted trust, the trust maker can access cash value through policy loans.

Irrevocable life insurance trusts can be individual trusts (which typically own an individual policy on the trust maker’s life) or they can be joint trusts created by a husband and wife (which typically own a survivorship policy on both lives).

Planning Tip:  Since federal estate tax is typically not due until the death of the second spouse to die, clients often use a joint trust owning a survivorship policy for estate tax liquidity purposes. However, a joint trust limits the trust makers’ access to the cash value during lifetime. In these circumstances, consider an individual trust with the non-maker spouse as beneficiary.


Clients can protect their assets from creditors by placing them in a well-drafted trust, and they can protect their beneficiaries from claims or creditors and predators by keeping those assets in trust over the beneficiary’s lifetime. By working together, the wealth planning team can ensure that the plan meets each client’s unique planning objectives.

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 the Opportunities with Aid & Attendance Benefits

Volume 2, Issue 8

A prior issue of our newsletter addressed the planning opportunities that exist with planning for Medicaid (Medi-Cal in California), particularly where the client’s advisors work together to create a plan that addresses all aspects of the client’s planning needs. This issue addresses a related topic, VA Aid and Attendance pension benefits.

Even advisors who focus on higher net worth clients should not discount the opportunities that exist with Aid and Attendance pension benefits. There are now over 25 million US veterans eligible for some type of VA benefits, many of whom have no idea Aid and Attendance pension benefits exist (and their local VA office won’t tell them about it!). Moreover, World War II veterans are dying at the rate of approximately 1,800 per day. Thus, the need for this type of planning is greater than ever.

What is Aid & Attendance?

Aid and Attendance is a “special monthly pension” available to wartime veterans or surviving spouses of wartime veterans. Aid and Attendance is not actually a stand-alone benefit. Rather, it is an additional allowance that a veteran or surviving spouse who is already entitled to certain VA pension benefits (because of his or her wartime service and non-service-connected disability) may additionally be entitled to upon meeting certain medical and financial requirements. Aid and Attendance differs from compensation, which is available to all veterans who suffer from a service-connected disability.

Planning Tip:  Aid and Attendance pension benefits are additional veterans’ benefits available to wartime veterans who need the “aid and attendance” of another to meet their daily needs.

Prerequisite Benefits

A veteran or surviving spouse (called a claimant by the VA) must first be eligible for what the VA refers to as “regular pension.” Regular pension is available when a wartime veteran (one with 90 days of active duty, and at least one day beginning or ending during a period of War) has limited income and assets and suffers from a non-service-connected permanent and total disability. In some circumstances, being over the age of 65 may qualify a claimant without the need to show a disability.

Permanent and total disability includes a claimant who is:

  1. In a nursing home;
  2. Determined disabled by the Social Security Administration;
  3. Unemployable and reasonably certain to continue so throughout life; or
  4. Suffering from a disability that makes it impossible for the average person to stay gainfully employed.

Asset & Income Requirements

The financial eligibility requirements of Aid and Attendance benefits address a claimant’s net worth and income. A married veteran and spouse can currently have no more than $80,000 in countable assets (less for a single veteran or surviving spouse), which includes retirement assets but excludes a home and vehicle. However, the $80,000 limit is a guideline only; it is not a rule set by the VA. The VA looks at a claimant’s total net worth, life expectancy, income and medical expenses to determine whether the veteran or surviving spouse is entitled to special monthly pension benefits.

Planning Tip:  Many times the advisor’s most difficult task in this area is to reduce a claimant’s assets down to the applicable level (or what one hopes will be acceptable to the VA). Like Medicaid planning, this often requires income tax planning and the utilization of financial products such as annuities.

There is no income limit for VA pension benefits. There is, however, what the VA refers to as Income for VA Purposes (IVAP), or a claimant’s gross income from all sources less countable medical expenses. If a claimant’s IVAP is equal to or greater than the annual benefit amount, the veteran or surviving spouse is not eligible for benefits.

Is the Claimant Housebound?

If a claimant qualifies for regular pension and is housebound, the claimant’s maximum allowable income increases (as does the annual benefit amount) to the special monthly pension. The VA defines housebound as being substantially confined to the home or immediate premises due to a disability that will likely remain throughout the claimant’s lifetime. A veteran with no dependents who is housebound is eligible for benefits of up to $13,356 in annual income.

Unreimbursed medical expenses will reduce a claimant’s income dollar for dollar. But remember, to be eligible for a special monthly pension for being housebound, the claimant’s IVAP must be less than the annual income threshold.

To illustrate, a veteran with exactly $13,356 in annual income would not be eligible for a special monthly pension for being housebound. However, if that veteran was able to show annual income of $20,000 and unreimbursed medical expenses of $25,000, the veteran would be eligible for $13,356 in annual special pension (paid on a monthly basis) because the veteran has negative IVAP. A surviving spouse with no dependents who is housebound can have an annual IVAP of up to $8,957.

Does the Claimant Require the Aid and Attendance of Another?

If a claimant can show, through medical evidence provided by a primary care physician or facility, that the claimant requires the aid and attendance of another person to perform activities of daily living, that veteran or surviving spouse may qualify for an additional monthly special pension commonly referred to as aid and attendance pension benefits.

The VA defines the need for aid and attendance as:

  1. Requiring the aid of another person to perform at least two activities of daily living, such as eating, bathing, dressing or undressing;
  2. Being blind or nearly blind; or
  3. Being a patient in a nursing home.
Planning Tip:  The maximum pension for a married veteran is $1,801 per month ($21,615 per year), while the maximum pension for a veteran’s widow is $1,165 per month ($13,976 per year). The VA pays this pension directly to the claimant, and it makes no difference whether the claimant receives medical care at home, in an assisted living facility or in a nursing home.


As stated above, the VA looks at a claimant’s total net worth, his or her life expectancy, and his or her income and expenses to determine whether the claimant should qualify for special monthly pension. Unlike Medicaid, there is no look-back period and no penalty for giving assets away. However, one must use caution when considering a gifting strategy to qualify a veteran or surviving spouse for special monthly pension benefits, as this will cause a period of ineligibility for Medicaid which could be as long as five years. Other Medicaid planning strategies may apply when trying to qualify a veteran or surviving spouse for special pension with aid and attendance.

Planning Tip:  The client’s advisors (particularly the attorney and financial advisor) must work together to determine the best combination of strategies and financial products that will gain eligibility for special monthly pension but not disqualify the client from Medicaid.

For example, Bob, an unmarried wartime veteran, suffers from dementia and needs help dressing, taking medication and bathing. He has assets of $150,000 and social security income of $1,100. Bob lives at home and pays a home health aide $2,000 per month. He has negative income for VA purposes (the applicable annual rate is $18,234 or $1,519 monthly) and is running short $900/month in covering his medical expenses. However, Bob’s assets will most likely prevent him from receiving improved pension with aid and attendance.

To qualify Bob for special monthly pension with aid and attendance, one option might be for him to use $100,000 of his assets to purchase an immediate annuity structured to pay less than $900 per month (the annuity should be actuarially sound so as not to cause a problem with Medicaid eligibility). Even with the annuity payment, Bob can a show negative annual income, assets of only $50,000, and he can show a medical need for the benefit. Therefore, Bob would most likely be eligible for the maximum annual pension rate of $18,234 (paid in monthly payments of $1,519.50).

The Application Process

While the application process for special monthly pension can be agonizingly slow – some applications take over a year before the VA makes a decision – the benefit is retroactive to the month after application submission. Having the proper documentation in place at the time of application (for example, discharge papers, medical evidence, proof of medical expenses, death certificate, marriage certificate and a properly completed application) can cut the processing time in half.

Planning Tip:  Benefits are retroactive to the month after application submission, so advisors should help clients apply as quickly as possible while also helping to ensure that the application is complete.


Even advisors who do not wish to practice in the area of Aid and Attendance special pension benefits should be able to recognize the opportunity for prospective and existing clients. They should also be ready to recommend someone who can assist in this area.

Because of the impact transfers may have on the client’s eligibility for other benefits such as Medicaid, it is critical that the client’s advisor team work together to maximize the benefits available to the client.

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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Life Settlements: Understanding the Opportunity for Your Clients

Volume 2, Issue 7

This month’s issue of our newsletter addresses a topic that many professionals do not understand fully, life settlements. For the right clients, a life settlement offers a significant advantage over the alternatives – and one that the client and the planning team should at least consider.

Life Settlements – The Basics

The secondary market for life insurance policies has entered the mainstream of financial services products. Therefore, advisors whose clients include seniors or aging baby boomers should have a working knowledge of how a life settlement can provide liquidity to meet a variety of estate planning and elder care needs.

A life settlement is a product for seniors (generally over the age of 70) who are seeking an economically sensible exit strategy from unwanted life insurance policies. A life settlement transaction involves the sale of an existing life insurance policy, typically valued at $250,000 or more, to an institutional investor (known as a “provider”) in exchange for a lump-sum payment greater than the cash surrender value, but less than the death benefit. The institutional buyer becomes the new owner of the policy, assumes responsibility for premium payments, and collects the death benefit upon the insured’s death.

Planning Tip:  Where the owner/insured no longer needs or desires a life insurance policy, a life settlement can generate significantly more income than a policy surrender. As long as the life settlement payment does not exceed “basis” or the premiums paid for the policy, the payment will not be subject to income tax.

Based on industry statistics, the average life settlement candidate is a 78 year-old male who owns a universal life insurance policy valued at $1.8 million, and the average lump sum payment typically ranges from 3 to 5 times the cash surrender value. In addition to universal life insurance policies, most other types of life insurance policies may qualify for a life settlement, including variable universal life (VUL); term policies (if convertible); whole life; survivorship; and group policies (if portable and convertible).

Planning Tip:  Life settlement offers from providers can vary widely. To obtain the highest possible value for a client’s life insurance policy, advisors should seek the services of an experienced settlement broker who can shop the market and obtain multiple offers from providers authorized to do business in the state in which the policy ownership resides. A listing of settlement brokers operating in the secondary market is available online at: http://www.lisassociation.org.

Life Settlements for VUL Policies Are Securities Transactions

Although universal life insurance policies comprise the bulk of life settlement transactions, VUL policies – particularly those with investments in subaccounts that have not performed according to market expectations – may be prime candidates for settlement in the secondary market. In August 2006, NASD issued Notice to Members 06-38 addressing member obligations with respect to the sale of existing VUL policies to third party investors operating in the secondary market for life insurance. This notice reminded us that, according to the NASD, the sale of a VUL policy is a securities transaction subject to applicable NASD rules.

Those elements of Notice 06-38 directly impacting the handling of VUL life settlement transactions concern:

    1. Establishing the client’s suitability for the product;

Conducting due diligence on the confidentiality practices of brokers and providers; Performing “best execution” by soliciting bids from multiple licensed providers; Establishing written procedures involving product training and supervision; and Prohibiting the payment of compensation on a transaction except by another member firm (broker-dealer).

Some broker-dealers have taken the position that although they will not proactively promote or advertise the product, they are putting procedures in place to make the option available to their registered reps in situations where a life settlement may be the most suitable solution for the client.

Planning Tip:  Following the issuance of NASD Notice 06-38, many independent broker-dealers began screening life settlement brokers and establishing preferred vendor relationships to service this business from their registered reps. Financial advisors should check with the broker-dealer home office regarding the procedures for transacting a VUL life settlement and any preferred vendor relationships.

Life Settlements for Trust-Owned Life Insurance

As baby boomers prepare themselves for the great wealth transfer, financial advisors and legal professionals are poised to establish more trusts. According to the results of the sixth annual “Industry Attitudes” survey published in October 2006 by InvestmentNews, 70 percent of the financial advisors responding to the survey indicated that they expected to set up a greater number of trusts for their clients.

This statistic is important because life settlement industry statistics indicate that approximately 40 percent of life insurance policies sold in the secondary market involve trust-owned life insurance policies. For financial and legal professionals acting as trustees or fiduciaries for trust-owned life insurance policies, or for any professional whose clients have trust-owned life insurance, conducting periodic reviews of policy performance is highly recommended.

For example, policies purchased with the expectation that policy values or dividends would be available to pay future premiums may now require additional premium payments to maintain coverage. In some cases, the trust makers may choose a life settlement for the underperforming policy and then use the proceeds from the life settlement toward replacement coverage with a better-performing product.

Planning Tip:  All wealth planning professionals whose clients have trust-owned life insurance should consider engaging an insurance professional with expertise in conducting regular policy reviews. Life insurance policies are complex financial instruments, and once a trustee discovers that a trust-owned life insurance policy is at risk, they will want to discuss all possible options with the insurance professional and the insured.

Common Uses for Life Settlements

There are numerous reasons why seniors choose a life settlement, but some of the most common scenarios are: (1) the preferred alternative to a 1035 exchange; (2) the insured’s estate tax burden has decreased and thus the insured’s beneficiaries no longer need liquidity to pay estate taxes; (3) the insured wants cash to give to family or their favorite charity; (4) the insured can no longer afford the policy or plans to surrender it; (5) the policy is a key-person policy and no longer needed by a retiring executive; (6) the insured needs funds for medical or long-term care.

Planning Tip:  Life settlements are often preferable to the client accepting a low cash surrender value or surrendering the policy.


Within the past five years, the secondary market for unwanted life insurance policies has grown exponentially and is now estimated to be a $20 billion industry. Due to increased regulatory oversight and the infusion of institutional capital from investment banks such as Credit Suisse, Bear Stearns, Goldman Sachs, Deutsche Bank, and foreign and domestic hedge funds, this emerging industry is approaching a plateau of tenability and maturation.

Consider working with an experienced insurance professional to conduct periodic reviews of your clients’ life insurance policies, and if suitable, recommend a life settlement.

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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