Children paying parents second to die policy

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Children paying parents second to die policy

Postby alewisdvm » Wed Jan 30, 2013 3:08 pm

Hello,
My father-in-law has a second to die policy. For some type of tax reasons, he gifts my wife money and then she pays the premium.
The beneficial for the seocnd to die is my wife and her brother.
Curious how this tax benefit works?

Also, the father-in-law is now getting divorced, but recommends that my wife and her brother continue the policy. It has cash value, but he strongly urges the benfits of keeping the policy intact. But, he nows wants my wife to pay for it (not gifting any money anymore).
Can we write off anything for payment on this policy?
Is it a good idea to keep the second to die policy intact. From what I understand, whether they are divorced or not, the policy still functions the same, that both of them must die before payment.

Thanks
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Re: Chidlren paying parents second to die policy

Postby MN Finance » Wed Jan 30, 2013 3:41 pm

My assumption is that the policy owner is your wife. This is a common estate planning strategy to shift money out of the parents estate without using more complex trusts. Because you can only gift $14k/yr without realizing a taxable gift, you can't just move, say $1M, out of parents name to kids. But you can effectively do the same thing by buying an insurance policy that has premiums less than $14k/yr and gift those.

By definition, the reason this strategy is used and the reason whole life policies are used, is because the insurance needs to stay in place until death and the whole thing is basically wasted if it's surrendered during the parents life.

Parents getting divorced and/or no longer deciding to gift the premiums is certainly a bad situation. But I think you can make some assumptions to determine if you want to pay the premiums yourself. You'd have to provide more facts. Let's say it's a $1M policy with $100k in cash value and mom and dad are both 90 and in poor health and the premium is $10k / year. Obviously it makes sense to pay $10k / year to get $1M in death benefit when they both pass away. Now, change the variables, and it may be less obvious.

(If a trust owns the policy it could be much more complicated).
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Re: Chidlren paying parents second to die policy

Postby alewisdvm » Wed Jan 30, 2013 5:58 pm

Understood.
I believe 500,000 policy. Second to die
Yes, my wife and her brother are co-owners of the policy, and she will be signing some paperwork to appoint me the second beneficiary if she were to die before them.

The cash value, I think, is about 85,000.

The request is that my wife would now pay about $2700/year and her brother the same amount to maintain the policy.

Hope that helps wife narrowing your answer.
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Re: Chidlren paying parents second to die policy

Postby MN Finance » Wed Jan 30, 2013 6:09 pm

Cutting the cash and death benefit in half means your wife has $42,500 and will add $2,700 / year to get a $250,000 benefit. If you assume a 4% investment return / discount rate, that's 27 years before you reach $250,000. If 4% is the right number (for say the conservative opportunity cost of you taking $42,500 now and adding $2,700,) then mom and dad would need to pass away 27 years from now to break even. If they pass away soon / later then keeping the policy in force would mean you come out ahead / behind. I don't know if these are the right assumptions, but it gives you an idea how you might look at it. I also ignored the tax free "growth" that life insurance provides, so you probably come out ahead even if they live beyond 27 yrs. On the other hand, you have the risk that brother doesn't pay his half and you're unwilling/unable to make his payments, and the policy could lapse before they pass away. And if someone lives to be very old, then the insurance won't be bad, but won't give you a huge net gain.
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Re: Children paying parents second to die policy

Postby texasdiver » Wed Jan 30, 2013 6:25 pm

My parents have the same thing. They gift me the money to pay the policy but I am co-beneficiary with my 2 brothers.

As I understand it the tax benefits are as follows: Most of my parents cash estate is in the form of traditional IRAs for which taxes were never paid and for which taxes would become due at the time of their death when we would inherit them. However, if, instead of us kids inheriting the IRAs, they instead donate their traditional IRAs to charitable organizations like churches or universities in their will, the donation is tax exempt and never gets paid. The charity gets the full value of the IRA and owes no tax.

At the same time, proceeds of life insurance policies are tax exempt, so my brothers and I will owe no tax whatever on the second to die policy that my parents took out.

Basically their financial advisor put them in this thing as a form of estate planning....as the most tax efficient way to donate part of their estate to the charities of their choice and pass part of it on to their kids tax-free. If their cash estate was primarily in the form of taxable accounts then this approach would make less sense. But since they mainly have 3 assets (pensions which we won't inherit, property which we will, and traditional IRAs that will owe tax) they felt this makes the most sense.

As to whether this is actually the most tax efficient way to accomplish what they want to do. I don't know...and frankly don't really care. It is their money and they are smart enough to dispense with it as they see fit. I'm not actually counting on an inheritance for anything anyway.
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Re: Children paying parents second to die policy

Postby bluemarlin08 » Wed Jan 30, 2013 6:42 pm

My father-in-law has a second to die policy. For some type of tax reasons


Typically, second to die policies are used to provide liquidity to an estate to pay estate taxes, usually due at the "second to die". If he is getting divorced, and has an estate that will incur estate tax, that tax will be due at his death. Unless his divorced wife predeceases him, the policy proceeds won't be available until her death. Secondly, as mentioned, your brother may decide to stop paying his portion in the future, or what if he dies, who will pay his share? I would have to think long and hard about this.
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Re: Children paying parents second to die policy

Postby MN Finance » Wed Jan 30, 2013 7:10 pm

bluemarlin08 wrote:
My father-in-law has a second to die policy. For some type of tax reasons


Typically, second to die policies are used to provide liquidity to an estate to pay estate taxes, usually due at the "second to die". If he is getting divorced, and has an estate that will incur estate tax, that tax will be due at his death. Unless his divorced wife predeceases him, the policy proceeds won't be available until her death. Secondly, as mentioned, your brother may decide to stop paying his portion in the future, or what if he dies, who will pay his share? I would have to think long and hard about this.


Or likely this was put in place many many years ago when the estate was indeed subject to 55% tax rate above 1M (accumulated cash value is 85k on 5k/yr in premiums). And in that case, if mom and dad are healthy AND the OP decides to keep the policy, it may actually make a lot of sense to even consider a new policy since insurance costs are lower. Would be a lot of work, but it's quite possible that the $85,000 could fully fund / pay up a slightly smaller policy and no new premiums would be needed. Not commenting on if there should be a policy at all, but if one continues, it doesn't hurt to go through underwriting.
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