Do we need irrevocable life insurance trust (ILIT)?

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EventHorizon
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Do we need irrevocable life insurance trust (ILIT)?

Post by EventHorizon » Sun Mar 22, 2015 9:36 pm

Longtime reader, first-time poster. I searched the forum on this topic, and wanted to ask for advice based on my specific situation:

Both mid 30s, dual income (my current income is significantly larger), one child under 10
Current net worth under 2 million, projected net worth 10+ million in 20 years
Considering 10 million dollar life insurance policy on myself, 20 year level term
The 20 year term would get our kid well out of college
Not planning whole/variable/universal life due to fees, and the fact that they are too complex for me to understand

My concern is: if spouse has to collect on the policy, that could makes our estate subject to estate tax when spouse passes (based on 2015 exemption of 10 million for a married couple)

Am thinking about creating an irrevocable life insurance trust to hold this policy, presume that would cost under 3,000 in lawyer fees
With ILIT, if spouse has to collect on the policy, ILIT would pull the payout out of our taxable estate

Planning to buy the higher premium term insurance anyway, so that is a sunk cost
Is the ILIT worthwhile?

Possible outcomes with ILIT:
1. early event (in first few years of the policy): I lose peak earning years, most of the payout will be spent on living expenses, spousal retirement, etc., so very unlikely that spouse will break current 10M estate cap with single income (including insurance payout). After the spenddown, estate tax is not an issue, so not much benefit to ILIT.
2. late event (just before policy expires): ILIT reduces taxable estate, residual estate might be about 10M, and spouse lives it up or our kid skips estate taxes, or both
3. no event (policy expires and I'm still standing, which is obviously my goal here :D ): we lose the setup cost of the ILIT, hopefully would be self-insured at that point, and then might try to buy some other type of insurance policy.

Since 20 years of premiums will be over 100,000, I'm okay with tossing another 3,000 in legal fees onto the bonfire.

Am I thinking about this in the right way?
Is it worth the time, hassle and expense?
Thanks in advance for your thoughts.

Lafder
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Lafder » Mon Mar 23, 2015 10:08 am

Have you met with an estate planning attorney and do you already have wills in place? They will help you sort out what is best. In a life insurance situation, we were told ours is set up so a trust happens when we die, but it is not in place until then, specifically for our life insurance proceeds, for our children.

In my opinion you are considering a huge life insurance policy that is way beyond what most high wage earners get. Do you really want to be worth more dead than alive?

In my opinion Life Insurance is to help your family get through your loss and not have to work immediately after. You are looking at a policy that would allow your spouse to never work and even your kid's kid's to be trust fund brats.

When we thought about life insurance, we thought of paying off the mortgage, college expenses, a few years of income and each have a million dollar policy. After that, our spouse needs to step up and take care of the family. Or if the kids are left orphans, the 4 million in life insurance and estate would be more than most would get.

Whoever is selling you a 10 million dollar policy is feeding into your own fears and would make a whopping commission off of selling that policy.

The premiums could be much better spent.

Do not forget to have some level of coverage for your spouse. Would you be able to keep working if something happened to your spouse? Ie even if your income is higher, your ability to work could be effected.

It was creepy to make our wills and get life insurance, and think about what happens if I die, or my spouse and I die at the same time. Be sure you have estate planning that well spells out what happens if your children are left orphans with this vast estate. Who would you trust to manage it ?

Best wishes and may we both outlive our life insurance policies! I believe we bought 30 years by the way, not 20.

lafder

BruDude
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by BruDude » Mon Mar 23, 2015 1:46 pm

If you are going to have that large of a life insurance policy, then yes you should set up an ILIT to remove the proceeds from the value of the estate. If you do not have the policy in an ILIT and the excess over the exemption becomes subject to the estate tax, it's going to cost your child(ren) and/or other heirs a big chunk of change when your spouse passes, along with making all other assets you accumulate subject to the tax. $10M is a pretty large policy and some insurance companies will require the policy to be re-insured with another carrier, which could make the underwriting more difficult if you are not in perfect health. The insurance company is also going to want detailed financial information and justification for the large benefit amount. You should be working with an experienced broker for a policy like this as there are more issues than you may be aware of, though it sounds like you have done some research on your own already.
Lafder wrote:In my opinion Life Insurance is to help your family get through your loss and not have to work immediately after. You are looking at a policy that would allow your spouse to never work and even your kid's kid's to be trust fund brats.

When we thought about life insurance, we thought of paying off the mortgage, college expenses, a few years of income and each have a million dollar policy. After that, our spouse needs to step up and take care of the family. Or if the kids are left orphans, the 4 million in life insurance and estate would be more than most would get.

Whoever is selling you a 10 million dollar policy is feeding into your own fears and would make a whopping commission off of selling that policy.
Some people want their family to never have to worry about money again if they pass, we don't know what OP's intentions are but it sounds like that is the case. You might be surprised how much the "whopping" commission is on a $10M 20-year term policy for someone in their mid-30's in good health. It's a nice case for any agent, but it's not a life-changer. We once had someone contact us looking for a quote on an NBA all-star player for a $50 million 10-year term policy funded by the team and it would have paid us about $9-10k in commission that would've been split with the other person....not that anyone would complain about that, but in comparison to the size of the death benefit, it's not as much as most people think it would be and there can be a lot more work involved than there would appear.

MN Finance
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by MN Finance » Mon Mar 23, 2015 4:10 pm

One question is the need for a 10M policy (which isn't your question). Is that amount accurately matched against your lost earnings over the next 20 years if you die tomorrow? If not, then that solves your problem.

If so, then you have to determine if the hassle is worth it. You have trust set up costs, possibly future amendments, and annual maintenance work. If the current estate exemption stays in place, it's inflation adjusted. Your policy is not. You are right on the boarder of the estate being taxable. If your portfolio grows at a dollar amount higher than the inflation amount of the estate exemption, then you might have a taxable estate, but it's not significantly in that space.

The other issue is that if you die, and your spouse is alive, you now have 10M in trust for your kids. You now have significant work/cost in carrying that trust through. That may be the case anyway if you both die with minors, but I see that as unneeded complication should youpredecease your spouse. It may also lead to unnecessary complications for your surviving spouses access to the funds.

vveat
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by vveat » Mon Mar 23, 2015 5:08 pm

Do you already have a living trust in place? If yes, setting an ILIT through the same estate lawyer may be minimal cost. I don't remember exactly anymore, but I think we paid less than $3,000 for the original living trust (which was a mountain of paperwork) and $500 or less extra for the ILIT.

The hassle is not much, but you need to set an account for the ILIT, managed by your spouse, and you shouldn't have access to it (in the spirit of removing this from the estate). Every year we fund it with the premium amount, and pay out of it. In between we do the so called "Crummey" letter required to avoid the beneficiaries arguing that the payment of the premium was not approved by them.

My understanding is also that in the event of my death, my husband will need to file separate return for the ILIT, until the ILIT is dissolved.

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EventHorizon
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by EventHorizon » Mon Mar 23, 2015 7:24 pm

Original poster, responding to questions

1. Do I really need a 10M policy?
A good question. 10M would be under 20x my gross annual income, so I thought it was a reasonable amount. I'm not being sold a policy right now, but I have had rising income and have not applied for a larger insurance policy in several years. I currently carry 2.5M, which has fallen to about 4x current gross income.

My goal is to provide income replacement, and I do not want my spouse to have to work longer hours to make up for the fact that single-parent income would be 15% of current values. I do play a role in school drop-offs and child care and if the money avoids a nanny/babysitter that would be ideal.
PS your questions make me remember that both my parents and in-laws are on less than ideal financial ground. Nursing homes, etc could easily suck up a million bucks here and there.

@ Lafder
Raising spoiled trust fund brats is definitely a concern, but the 10M would be around 20 years of post-tax income at current tax rates, so I thought it was a reasonable amount. It's certainly not the bare minimum, but I would rather aim a bit high and let my spouse and kids donate heavily to charity or do something else worthwhile. My spouse supports my Boglehead mindset but is not really interested in the day-to-day dollars and cents.
Perhaps I overestimate my worth to the family, but I'd like to think darling spouse would be heartbroken, and I don't want the family to have to live on 15% of current income (ie spouse's salary alone).

@ BruDude
When selecting a policy amount, I was looking to replace 20 years of income. A pretty standard multiple?

@ MNFinance
I assumed that my spouse would have free access to the ILIT proceeds as a trustee/beneficiary. Not true?

Theoretical
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Theoretical » Mon Mar 23, 2015 7:48 pm

Let me start out: I am an estate planning attorney and do not sell life insurance.

First question - are you in a separate property state or a community property state? It's very important to address. This will determine a lot of the back-end complexity you'll need to address annually.

Second question - are you buying this contingent block of money for your child or are you buying it for your spouse?

The next most important question to ask with an ILIT is what you are trying to create with the insurance. Is it
(1) Trying to create a specific chunk of money for the next 20 years, no matter whether the rest of your net worth is $5 or $50,000,000 or is it
(2) Purchasing a policy to prevent your children (your wife won't have to worry about this as long as she's a US citizen) from having to sell your property to pay the estate taxes.

If it's goal number 1, then this sized policy is worthwhile and putting it in an ILIT is workable; however, ILITs can be a real pain in the neck for no guarantee of any benefit (when it's funded with Term). Crummey withdrawal notices, partition agreements (with community property), and other things can be administratively exhausting to work with. Lots of clients hate the things and some of those clients don't faithfully do the legwork they need to do and the trust becomes exposed to the estate tax after all.

If it's goal number 2, you do not need to buy a full $10 million insurance to address where you plan to have your finances in 20 years (10 million), because even at the old 55% tax rates you only would need $4.44 million (assuming a $1 million exemption x2 deaths). The amount of insurance to purchase would be the amount you think between the current doubled estate tax exemption and the doubled level of what you are concerned the estate tax exemption would be over the next 20 years. It's very unlikely that the exemption would ever go back to $650,000, but it is certainly possible that the exemption might be rolled back to say $4-4.5 million and no longer be inflation-indexed in a Democratic Congress and President. Just like setting your stock/bond allocation, this is a risk assessment on what low level of estate tax exemption you're willing to accept.

In the estate planning world ILITs are virtually never funded with term insurance; however, that does not mean you should instead instead get whole insurance ( :shock: :shock: :shock: at those premiums for that sized policy). Instead, ILITs are typically funded with universal life insurance that is almost entirely weighted towards the death benefit, but that has a small reservoir of cash value where the dividends offset rising premiums as you get older. Instead of a 10 or 20 year term, it's annual, automatically renewed term insurance. Also, if it's goal number 2, then typically what is used is second-to-die life insurance, which is even cheaper permanent insurance, because it's tied to both you and your wife's lives, and (health considerations notwithstanding), that's a much better risk for the insurance company.

The other risk you are taking is that the difference between insuring yourself now vs. insuring yourself 20 years from now is breathtaking. A lot of chronic conditions hit in the late 40s and early 50s that cause skyrocketing life insurance premiums, to the point where you could be paying close to what you'd pay now for whole life for just a term policy.

Topic Author
EventHorizon
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by EventHorizon » Mon Mar 23, 2015 8:09 pm

@Theoretical
Your questions required me to do some thinking.

1. This is a separate property state.
2. The money is for my spouse/child to live on and for my wife to retire on.
3. I choose goal #1: to provide a chunk of money for income replacement, not for estate planning.
I'm not looking for 10 million to pay estate tax on assets 20 years from now, I'm looking for 10 million to BE my assets if I am not around to collect a paycheck. I was thinking about throwing an ILIT onto planned term insurance, and not really thinking about other insurance types. That being said, do you see a role for universal life for me right now?

Given the conservative nature of my projections, any small variation could mean that our net worth in 20 years (outside of life insurance) might be 10M, but could easily be 15M.
In 20 years, I hope to not need life insurance for income replacement, but might need to address goal #2 at that point with some serious estate planning.
Second-to-die insurance is interesting, but I was going to save those more complicated options for when we definitely have a taxable estate.
Last edited by EventHorizon on Mon Mar 23, 2015 8:12 pm, edited 1 time in total.

Theoretical
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Theoretical » Mon Mar 23, 2015 8:12 pm

EventHorizon wrote:Original poster, responding to questions

1. Do I really need a 10M policy?
A good question. 10M would be under 20x my gross annual income, so I thought it was a reasonable amount. I'm not being sold a policy right now, but I have had rising income and have not applied for a larger insurance policy in several years. I currently carry 2.5M, which has fallen to about 4x current gross income.

My goal is to provide income replacement, and I do not want my spouse to have to work longer hours to make up for the fact that single-parent income would be 15% of current values. I do play a role in school drop-offs and child care and if the money avoids a nanny/babysitter that would be ideal.
PS your questions make me remember that both my parents and in-laws are on less than ideal financial ground. Nursing homes, etc could easily suck up a million bucks here and there.

Take a look at your current expenses. How much is a recurring debt payment such as student loans and mortgage payments affecting your current income? The freed up cashflow from paying debts (yours and spouse's) may reduce the income needed while preserving the current lifestyle.


@ Lafder
Raising spoiled trust fund brats is definitely a concern, but the 10M would be around 20 years of post-tax income at current tax rates, so I thought it was a reasonable amount. It's certainly not the bare minimum, but I would rather aim a bit high and let my spouse and kids donate heavily to charity or do something else worthwhile. My spouse supports my Boglehead mindset but is not really interested in the day-to-day dollars and cents.
Perhaps I overestimate my worth to the family, but I'd like to think darling spouse would be heartbroken, and I don't want the family to have to live on 15% of current income (ie spouse's salary alone).

$10 million is a huge amount of money for a child to inherit, even if your current lifestyle is very consistent with a $500K net income. All kinds of predators and unsavory scoundrels come out of woodworks to try to get their hands on some of his money. Frankly, the same is often true with your wife, especially if she is not as savvy about these things. The other thing is that it can really hurt his ability to live independently and it can disappear quickly if he can't manage the income well (virtually no 20 year old can). 20x current income is a lot to pass down merely for its own sake.

@ BruDude
When selecting a policy amount, I was looking to replace 20 years of income. A pretty standard multiple?

For your wife, yes. For your son, not so much given your income, unless you specifically want him to start at the very high standard of living you are currently at with his earnings and spending augmenting it.

@ MNFinance
I assumed that my spouse would have free access to the ILIT proceeds as a trustee/beneficiary. Not true?

Typically this is the case with the approach you've described. If her life is also insured (estate tax payments), then she's also ineligible. You will not be able to serve as trustee no matter what.

Topic Author
EventHorizon
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by EventHorizon » Mon Mar 23, 2015 8:30 pm

Good point about evaluating my needs rather than just seeking a 20X income policy.
There are some medical issues in my family, so trying to get a larger policy while my health is decent is a consideration.

Re current monthly expenses:
monthly savings 25,000+
mortgage 4000 (our only debt)
extra principal 2500 (to pay off loan in 10 more years)
college savings 2200 (not planning to continue at this level forever)
residual current monthly expenses 6500

However, favor large insurance policy to build a retirement portfolio and to pay for college moreso than merely to cover living expenses.

Theoretical
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Theoretical » Mon Mar 23, 2015 8:40 pm

EventHorizon wrote:@Theoretical
Your questions required me to do some thinking.

1. This is a separate property state.

That makes it simpler for IRS purposes. A LOT simpler.

2. The money is for my spouse/child to live on and for my wife to retire on.

To rephrase it, if you are in an different economic position in 20 years, say making the equivalent of $200K or even $125K, are you ok with the estate you'd be leaving providing only that income when you reevaluate this in 2035? If the answer is yes, then 20 year term is for you. If no, then universal life is the only inexpensive option.

3. I choose goal #1: to provide a chunk of money for income replacement, not for estate planning.
I'm not looking for 10 million to pay estate tax on assets 20 years from now, I'm looking for 10 million to BE my assets if I am not around to collect a paycheck. I was thinking about throwing an ILIT onto planned term insurance, and not really thinking about other insurance types. That being said, do you see a role for universal life for me right now?

Given the conservative nature of my projections, any small variation could mean that our net worth in 20 years (outside of life insurance) might be 10M, but could easily be 15M.
In 20 years, I hope to not need life insurance for income replacement, but might need to address goal #2 at that point with some serious estate planning.
Second-to-die insurance is interesting, but I was going to save those more complicated options for when we definitely have a taxable estate.

The main problem with life insurance is that as you get older, the cost increases and even the availability of insurance dries up. Frankly, I'm a lot more concerned about you having adequate disability insurance, because that's the much greater risk to your current income. Incapacity planning needs to be a key part of your estate plan, whatever lawyer you hire, especially in your case.

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BL
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by BL » Mon Mar 23, 2015 8:53 pm

Not everyone is aware that minor children of a diseased Social Security covered person are eligible for Social Security, along with parent of child under 16. Here is one SS link explaining some of that:
http://www.ssa.gov/planners/survivors/onyourown5.html

Theoretical
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Theoretical » Mon Mar 23, 2015 11:10 pm

A couple of additional points as to the income to figure in.

You're using life insurance to "create an estate."

There's a couple of variables for you to consider in determining the amount per month that is available:
  • First, you should have enough insurance to meet these goals 100%:
  • Pay off the house, or pay off enough equity that your wife would have her dream downsize home (if you know she'd downsize)
  • Prefund an account to be conservatively invested to meet medical needs
  • Fully fund your child's college education
Say that's $X million.

Once that list is complete, then you have knocked out about $8700 in expenses per month. That leaves monthly expenses of $6,500. That's 78,000 per year. One important difference between your wife's financial position on inheritance versus your own as a wage-earner is that she is not paying FICA taxes on the earnings from the investments, and (right now) she would get the benefit of the low capital gains and qualified dividends rates until she is earning $450,000 per year). You're in a very high bracket, possibly also with some state taxes, and you have to pay FICA on the first $108,000 of your earnings. Assuming you lose half of your salary to taxes, you have to make at least $150,000 to equal the standard of living she only needs $92,000 to earn. Even if qualified dividends go back up to full tax rates, she'll still have lower tax brackets to fill with income and she can invest in a way that favors long-term capital gains, minimal dividends, and AMT-free municipal bond income. Oh and even at the full marginal rates (say she only invests in REITS and treasuries) - it's still ~92-95,000 per year to equal $78,000 or so in post-tax income. This by, the way, is also assuming there's no MuniBond tax-free income coming out. For these figures, I'm using the 2015 tax brackets, but NOT using the dividends worksheet (the tax rate would be even lower).

Head of household, Family HSA, and self+dependent are being assumed.

A little under 2.5 million gives a cushion to provide $95,000 per year of withdrawals/income.

Finally, include the amount over all of these amounts that you intend to see saved and reinvested in the trust.

For withdrawals, you can generally safely withdraw 4% of the total assets of the trust every year and sustain it at its principal. So the equation is:

Prepayments/payoffs - $X.X million
Current Living Expenses - $2.5 million
Trust Appreciation Seed Money - Y.Y Million

If she chose to work, she could simply divert much of her income to a 401k plan, where the benefits matter way more than the salary and save on her taxes, while giving her greater income in the futre. Imagine negotiating a position to be paid $10/hour, health benefits, and a great 401k. She then dumps almost all of her earnings into the 401k and voila, she's almost back to saving the full amount. It means she could find work that she really wants to do and can focus on non-salary compensation and/or quality of life.

staythecourse
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by staythecourse » Tue Mar 24, 2015 12:31 am

Who in the world needs 10 million? Especially, a working spouse with only one child.

The idea of life insurance is not to PROSPER if you die, but to take care of what most would consider the essentials so the other spouse does not have to stress (physically or mentally) while potentially raising the kid/kids on their own.

What I would consider reasonable (not that you asked): Paying off the mortgage, paying of kids education (in your case just one), and paying for any care extender as your wife would likely need to go back to work to make a living.

Personally, the idea is life insurance is not: "If I die my spouse and kids can just sit back and hang out at the pool with the other socialites". If you die I am nearly sure your wife is not looking to spend MORE time off without anyone to spend it with (in view of her having a current career while you are alive).

Do as you wish, but have a hard time thinking of more then 2-3 million for 20 yrs. term unless your current spending habits justify higher.

Most mix up life insurance with investing you seem to be mixing up life insurance with winning the jackpot/ lottery.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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EventHorizon
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by EventHorizon » Tue Mar 24, 2015 6:09 am

@Theoretical
Pay off house 500K
Fully fund college 500K
Medical fund 1M (4K withdrawals to hopefully cover wife, parents, in-laws)
2.5M to generate 100K withdrawals at 4% to supplement income
2.5M seed money
Total 7M

What about ILIT with that amount?

@staythecourse
I'm a fan of your posts.
Admittedly, part of the reason for a large policy is my guilt about possibly leaving her alone. Separating emotion from finances is a good point.

A clarification:
Most of the members here are not planning to live a life of conspicuous excess once they retire, even if they have the means to do so, and neither are we. We're on track to have a large portfolio but not planning to be by the pool. I don't think that would change if my spouse ends up with a large portfolio from life insurance.
My spouse is a physician, and enjoys the work. IMO her salary is low for the time expended.

Life insurance is not the lottery. To me, staying on course and continuing to live beneath our means is our golden ticket.
If a carefully planned life means a large portfolio and financial independence, should a carefully planned death not lead to the same result?

Your opinion on ILIT?

Userdc
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Userdc » Tue Mar 24, 2015 7:00 am

a carefully planned death
Don't give your wife any ideas.

I don't know anything about ILITs, but I will echo the others who think $10M is way too much for your situation.

Focus on replacing needs, not income. And don't forget about social security death benefit for the kids.

At the very least, consider laddering policies so you aren't paying a 20 year premium on that full amount when it sounds like your needs will rapidly decline.

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by ChrisC » Tue Mar 24, 2015 12:33 pm

Theoretical wrote:Let me start out: I am an estate planning attorney and do not sell life insurance.

* * *

If it's goal number 2, you do not need to buy a full $10 million insurance to address where you plan to have your finances in 20 years (10 million), because even at the old 55% tax rates you only would need $4.44 million (assuming a $1 million exemption x2 deaths). The amount of insurance to purchase would be the amount you think between the current doubled estate tax exemption and the doubled level of what you are concerned the estate tax exemption would be over the next 20 years. It's very unlikely that the exemption would ever go back to $650,000, but it is certainly possible that the exemption might be rolled back to say $4-4.5 million and no longer be Inflation-indexed in a Democratic Congress and President. Just like setting your stock/bond allocation, this is a risk assessment on what low level of estate tax exemption you're willing to accept.

* * *


Also, if it's goal number 2, then typically what is used is second-to-die life insurance, which is even cheaper permanent insurance, because it's tied to both you and your wife's lives, and (health considerations notwithstanding), that's a much better risk for the insurance company.
I really appreciated your earlier posts on this subject. I tinkered with the idea of having an ILIT policy several years ago when the exemption levels were much lower and the projections for our estate would have us exposed to substantial estate taxes. Back then, we never got quotes for annual premiums. The increased exemption levels the past few years changed our thinking and we placed the idea on hold, but this thread made me think again that twenty years from now we could be faced with some exposure to estate taxes. Do you have any idea how expensive it would be for second-to-die insurance to take care of goal number 2 for a couple now at 63 and 61, if they wished to purchase a ILIT policy to solely cover potential exposure for $2-3 million above the exemption amounts? I'm thinking about going to a fee-based CFP to see if this is a risk I should insure against.
Last edited by ChrisC on Tue Mar 24, 2015 2:23 pm, edited 1 time in total.

Spencer
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Spencer » Tue Mar 24, 2015 1:10 pm

ChrisC wrote: I really appreciated your earlier posts on this subject. I tinkered with the idea of having an ILIT policy several years ago when the exemption levels were much lower and the projections for our estate would have us exposed to substantial estate taxes. Back then, we never got quotes for annual premiums. The increased exemption levels the past few years changed our thinking and we placed the idea on hold, but this thread made me think again that twenty years from now we could be faced with some exposure to estate taxes. Do you have any idea how expensive it would be for second-to-die insurance to take care of goal number 2 for a couple now at 63 and 61, if they wished to purchase a ILIT policy to solely cover potential exposure for $2-3 million above the exemption amounts? I thinking about going to a fee-based CFP to see if this is a risk I should insure against.
Is there a reason you need life insurance to cover the estate tax burden vs. simply selling liquid assets to cover the tax bill? Most ILIT seems to be geared as a liquidity source to cover estate taxes on illiquid assets such as private businesses, real estate, etc that are not easily liquidated (or do not want to be liquidated by heirs).

Additionally, if your estate is below the exemption now, and you are worried about the grow eclipsing it, you can start to setup freeze techniques (ie, rolling GRAT ladder) to shift the growth to your heirs, and out of your estate. You can also look at structuring your estate in ways to make it eligible for a discounted valuation (ie, family limited partnership).

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by BruDude » Tue Mar 24, 2015 1:48 pm

ChrisC wrote:
Theoretical wrote:Let me start out: I am an estate planning attorney and do not sell life insurance.

* * *

If it's goal number 2, you do not need to buy a full $10 million insurance to address where you plan to have your finances in 20 years (10 million), because even at the old 55% tax rates you only would need $4.44 million (assuming a $1 million exemption x2 deaths). The amount of insurance to purchase would be the amount you think between the current doubled estate tax exemption and the doubled level of what you are concerned the estate tax exemption would be over the next 20 years. It's very unlikely that the exemption would ever go back to $650,000, but it is certainly possible that the exemption might be rolled back to say $4-4.5 million and no longer be Inflation-indexed in a Democratic Congress and President. Just like setting your stock/bond allocation, this is a risk assessment on what low level of estate tax exemption you're willing to accept.

* * *


Also, if it's goal number 2, then typically what is used is second-to-die life insurance, which is even cheaper permanent insurance, because it's tied to both you and your wife's lives, and (health considerations notwithstanding), that's a much better risk for the insurance company.
I really appreciated your earlier posts on this subject. I tinkered with the idea of having an ILIT policy several years ago when the exemption levels were much lower and the projections for our estate would have us exposed to substantial estate taxes. Back then, we never got quotes for annual premiums. The increased exemption levels the past few years changed our thinking and we placed the idea on hold, but this thread made me think again that twenty years from now we could be faced with some exposure to estate taxes. Do you have any idea how expensive it would be for second-to-die insurance to take care of goal number 2 for a couple now at 63 and 61, if they wished to purchase a ILIT policy to solely cover potential exposure for $2-3 million above the exemption amounts? I thinking about going to a fee-based CFP to see if this is a risk I should insure against.
A second to die policy at your age would cost about 1-1.5% of the death benefit per year depending on the health risk classes assigned for you and your wife. For $2M you would be looking at $20-30k per year, $20k range for Preferred Plus (the best risk class) and $30k range for Standard (normal life expectancy) risk classes.

BruDude
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by BruDude » Tue Mar 24, 2015 1:55 pm

Spencer wrote:
ChrisC wrote: I really appreciated your earlier posts on this subject. I tinkered with the idea of having an ILIT policy several years ago when the exemption levels were much lower and the projections for our estate would have us exposed to substantial estate taxes. Back then, we never got quotes for annual premiums. The increased exemption levels the past few years changed our thinking and we placed the idea on hold, but this thread made me think again that twenty years from now we could be faced with some exposure to estate taxes. Do you have any idea how expensive it would be for second-to-die insurance to take care of goal number 2 for a couple now at 63 and 61, if they wished to purchase a ILIT policy to solely cover potential exposure for $2-3 million above the exemption amounts? I thinking about going to a fee-based CFP to see if this is a risk I should insure against.
Is there a reason you need life insurance to cover the estate tax burden vs. simply selling liquid assets to cover the tax bill? Most ILIT seems to be geared as a liquidity source to cover estate taxes on illiquid assets such as private businesses, real estate, etc that are not easily liquidated (or do not want to be liquidated by heirs).

Additionally, if your estate is below the exemption now, and you are worried about the grow eclipsing it, you can start to setup freeze techniques (ie, rolling GRAT ladder) to shift the growth to your heirs, and out of your estate. You can also look at structuring your estate in ways to make it eligible for a discounted valuation (ie, family limited partnership).
If you owe the tax, why pay the government 100% of the tax when the insurance company will do it for you at ~0.5-1.5% of the net amount per year? As posted in the example above, a $2M second to die policy would be around $20-30k per year. If they die in year one, they paid $20k for a $2M tax-free benefit. If they die at age 85, they paid out ~$500k for a $2M tax-free benefit. How easily can someone over age 70 generate $3-4M of pre-tax money (remember the life insurance money is tax-free) through investments to pay those taxes? People get more risk-averse as they get older, so they aren't going to be in high-risk investments. They would have to earn 12-14% interest over 25 years to generate $2M post-tax on a $20k annual investment. Obviously the numbers are pretty variable for what someone would pay for a policy and what kind of returns they could actually generate at that age through investments, but you get the idea.

dhodson
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by dhodson » Tue Mar 24, 2015 1:57 pm

One should keep in mind that if someone lives a normal lifespan according to their health rating then likely they could have more money by using something other than life insurance within an irrevocable trust.

While no lapse guaranteed universal with low CSV is typically what people recommend, one should realize these death benefits are greatly over the state guaranty association limits (which is a safety net of sorts and is not backed by state or federal money). If I'm not mistaken just last month, one of the gUL players, Transamerica pulled its gUL product without previous notice. Even applications that were then pending were not accepted. I assume they made the determination that these things might not turn out to be profitable for them.......

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Theoretical » Tue Mar 24, 2015 2:02 pm

EventHorizon wrote:@Theoretical
Pay off house 500K
Fully fund college 500K
Medical fund 1M (4K withdrawals to hopefully cover wife, parents, in-laws)
2.5M to generate 100K withdrawals at 4% to supplement income
2.5M seed money
Total 7M

What about ILIT with that amount?

@staythecourse
I'm a fan of your posts.
Admittedly, part of the reason for a large policy is my guilt about possibly leaving her alone. Separating emotion from finances is a good point.

A clarification:
Most of the members here are not planning to live a life of conspicuous excess once they retire, even if they have the means to do so, and neither are we. We're on track to have a large portfolio but not planning to be by the pool. I don't think that would change if my spouse ends up with a large portfolio from life insurance.
My spouse is a physician, and enjoys the work. IMO her salary is low for the time expended.

Life insurance is not the lottery. To me, staying on course and continuing to live beneath our means is our golden ticket.
If a carefully planned life means a large portfolio and financial independence, should a carefully planned death not lead to the same result?

Your opinion on ILIT?
Laddering the insurance makes a lot of sense. You might consider breaking it into half or thirds, something maybe like a $4 million for 7 years, $3 million for 14 years, and 3 million for 20 years. On the other side, you can request to be pre-underwritten for X amount and then take out X-Y amount of insurance, with the plan to scale it up or down in the future. Your premium would obviously be higher for that privilege, but that is another option.

What I think becomes really bad psychologically is having a situation in year 19 where you are worth $20 million and the next year you'll only be worth $10 million, especially considering inflation, disability, career/company decline or setbacks mid-life crises and changes, and becoming an empty-nester. You don't want to accidentally pre-plan an outbreak of major depression while having a major incentive to commit suicide. It's a Wonderful Life type situations happen all the time, especially for men like yourself with really strong desires to be a provider. I'd also reiterate the aspect of disability insurance playing a role here.

As for your wealth projections, a lot depends on whether you are earning this as a high dollar professional (say eye doctor, big law firm partner, or hedge fund manager) or as a CEO of a rapidly growing business. The former has a serious risk of professional incapacity (malpractice suit or getting your hand damaged if a surgeon), and the latter has the risk of the business simply falling short. Most estate planners recommend revisiting estate plans every 5 years for precisely this reason.

I can't tell you whether to get one or not. I can only tell you the logistical aspects and what factors planners use in determining the right size for an ILIT. How much or little insurance you want and need is really up to you.

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by ChrisC » Tue Mar 24, 2015 2:53 pm

Spencer wrote:
ChrisC wrote: I really appreciated your earlier posts on this subject. I tinkered with the idea of having an ILIT policy several years ago when the exemption levels were much lower and the projections for our estate would have us exposed to substantial estate taxes. Back then, we never got quotes for annual premiums. The increased exemption levels the past few years changed our thinking and we placed the idea on hold, but this thread made me think again that twenty years from now we could be faced with some exposure to estate taxes. Do you have any idea how expensive it would be for second-to-die insurance to take care of goal number 2 for a couple now at 63 and 61, if they wished to purchase a ILIT policy to solely cover potential exposure for $2-3 million above the exemption amounts? I thinking about going to a fee-based CFP to see if this is a risk I should insure against.
Is there a reason you need life insurance to cover the estate tax burden vs. simply selling liquid assets to cover the tax bill? Most ILIT seems to be geared as a liquidity source to cover estate taxes on illiquid assets such as private businesses, real estate, etc that are not easily liquidated (or do not want to be liquidated by heirs).

Additionally, if your estate is below the exemption now, and you are worried about the grow eclipsing it, you can start to setup freeze techniques (ie, rolling GRAT ladder) to shift the growth to your heirs, and out of your estate. You can also look at structuring your estate in ways to make it eligible for a discounted valuation (ie, family limited partnership).
I'm really a novice here. What is "start to setup freeze techniques (ie, rolling GRAT ladder)?"

My goal is to make it easier for the beneficiaries; perhaps I should just let them liquidate and slice and dice and deal with potential estate tax burdens. I didn't think the ILIT made much sense to my situation, but this thread got me thinking a bit. And I'm probably overthinking this too.

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EventHorizon
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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by EventHorizon » Tue Mar 24, 2015 2:54 pm

@Theoretical
We're both physicians (non-procedural specialties). I do have own-occupation disability insurance.

Will consider laddering. I have a pretty healthy self-worth, but I appreciate your perspective that being worth more dead than alive can put pressure on someone.

@Spencer
I was thinking of insurance to replace my income rather than pay estate taxes, which makes me consider a shorter 20-year term policy. I was considering an ILIT simply to pull the large payout out of our taxable estate, in case my spouse has to collect. Why pay more taxes than you have to, that sort of thing.

I was going to delay thinking about more complex trusts until we definitely have a taxable estate (and until our kid is a bit older and we can think about how much guidance to build into a trust).

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by dhodson » Tue Mar 24, 2015 3:11 pm

In my view (and I too am a physician), its much better to just give items away (remove them from the estate) while you are living. Not only are people more likely to need them before you die, you can receive some joy from seeing the good work you do. I am not aware of any ability to perceive joy once dead. Don't set yourself up for having an estate problem. Those limits are pretty high considering its over 10.2 million for you and your spouse (federal).

I'll agree good disability insurance is valuable. Its unfortunately very expensive (besides the fact that disability is "relatively" common) but you don't have much of a choice if you want it. Whitecoatinvestor.com has multiple articles on it and life insurance.

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Spencer » Tue Mar 24, 2015 3:53 pm

BruDude wrote:
If you owe the tax, why pay the government 100% of the tax when the insurance company will do it for you at ~0.5-1.5% of the net amount per year? As posted in the example above, a $2M second to die policy would be around $20-30k per year. If they die in year one, they paid $20k for a $2M tax-free benefit. If they die at age 85, they paid out ~$500k for a $2M tax-free benefit. How easily can someone over age 70 generate $3-4M of pre-tax money (remember the life insurance money is tax-free) through investments to pay those taxes? People get more risk-averse as they get older, so they aren't going to be in high-risk investments. They would have to earn 12-14% interest over 25 years to generate $2M post-tax on a $20k annual investment. Obviously the numbers are pretty variable for what someone would pay for a policy and what kind of returns they could actually generate at that age through investments, but you get the idea.
My point was, plan now, and owe the government nothing at all. If you are close to the exemption limit, it's fairly easy to divert growth to your heirs, and keep your estate under the limit.

Whether life insurance is a "good investment," I have not seen that from past quotes/scenarios assuming the insured lives to his/her expected age. It's not feasible for an insurer to stay in business providing 12-14% "returns" on the premiums. Mortality credits are not that high.

Additionally, folks who have $10mm+ estates are investing for generations. Generally no need to transition to a low-risk fixed income portfolio at those dollar levels.
I'm really a novice here. What is "start to setup freeze techniques (ie, rolling GRAT ladder)?"

My goal is to make it easier for the beneficiaries; perhaps I should just let them liquidate and slice and dice and deal with potential estate tax burdens. I didn't think the ILIT made much sense to my situation, but this thread got me thinking a bit. And I'm probably overthinking this too.
Freeze techniques generally allow you to divert growth above the IRS 7520 rate (currently 1.8%) to beneficiaries tax-free. As a VERY simple example, a 2 year GRAT that gains 10%, would divert 8.2% of it's growth to your heirs tax free. This basically freezes your estate's value, and diverts the majority of the growth to your heirs. There are other techniques to freeze your estate, but this is beyond the scope of the thread. I'm sure a google search on the subject could keep you very busy.

Again, my point was to plan ahead to avoid the estate tax, rather than going the ILIT route.
@Spencer
I was thinking of insurance to replace my income rather than pay estate taxes, which makes me consider a shorter 20-year term policy. I was considering an ILIT simply to pull the large payout out of our taxable estate, in case my spouse has to collect. Why pay more taxes than you have to, that sort of thing.

I was going to delay thinking about more complex trusts until we definitely have a taxable estate (and until our kid is a bit older and we can think about how much guidance to build into a trust).
My previous post was intended for someone else. I understand your situation is much different.

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by bsteiner » Tue Mar 24, 2015 9:44 pm

Now that the Federal estate tax exempt amount is $5,430,000 (indexed), and portability has been made permanent, we're doing far fewer insurance trusts than we once did. To the extent the insurance replaces the lost earnings if the insured dies early, the family will need to spend much of it.

If you were to die with $7 million of insurance and $2 million of other assets, your family would have $9 million. You could leave the exempt amount ($5,430,000 in 2015) to the credit shelter trust, and the rest ($3,570,000 in 2015, less any debts and expenses) to your spouse, either outright or in a marital trust. Your spouse would use the marital share first, so it might not grow to be more than the estate tax exempt amount. The credit shelter trust, including the income and growth on it during your spouse's lifetime, would be free of estate tax. The likelihood of paying estate tax isn't that great.

If you're in a state that has a state estate tax, with a lower exempt amount than the Federal, the planning becomes more complicated.
vveat wrote:Do you already have a living trust in place? If yes, setting an ILIT through the same estate lawyer may be minimal cost. I don't remember exactly anymore, but I think we paid less than $3,000 for the original living trust (which was a mountain of paperwork) and $500 or less extra for the ILIT.

The hassle is not much, but you need to set an account for the ILIT, managed by your spouse, and you shouldn't have access to it (in the spirit of removing this from the estate). Every year we fund it with the premium amount, and pay out of it. In between we do the so called "Crummey" letter required to avoid the beneficiaries arguing that the payment of the premium was not approved by them. ...
There was nothing in the facts presented that would suggest that a living trust would be appropriate. Living trusts are overhyped and oversold, and for most people, in most states, aren't worth the effort. They're common in California for reasons specific to California, but the original poster doesn't live in California.

If the original poster wants to do an insurance trust, given the amount involved, the $3,000 one will probably be better than the $500 one, in the same way that a $500 Will is probably sufficient for a high percentage of the population but not for the person with $9 million.

While some people create separate bank accounts for insurance trusts, many don't. If the spouse is the trustee, and the children are minors, she doesn't have to send Crummey notices to herself on behalf of the children.
EventHorizon wrote:... I assumed that my spouse would have free access to the ILIT proceeds as a trustee/beneficiary. Not true?
A trustee can't participate in decisions to make distributions to himself/herself (except for an ascertainable standard such as health, maintenance and support, but there are reasons not to permit a trustee to participate in distributions to himself/herself even for these items). So your spouse will need a co-trustee after your death. If you give your spouse the power to remove and replace his/her co-trustee (provided the replacement trustee is not a close relative or subordinate employee), then your spouse will effectively control the trust. This is the same regardless of whether it's an insurance trust or a credit shelter trust (or a marital trust, except that the spouse must be entitled to all of the income of the marital trust).
dhodson wrote:One should keep in mind that if someone lives a normal lifespan according to their health rating then likely they could have more money by using something other than life insurance within an irrevocable trust. ...
Good point. Also, when the parents die, the children will receive their inheritance, which is likely to be large. So the children will have plenty of money at that point. The children might prefer to receive their gifts in the form of cash that they can spend rather than premium payments on insurance policies.

Since there would be $9 million upon your death, you should have a Will (and, if desired, an insurance trust) to provide for the disposition of the $9 million in an appropriate way if you were to die after buying the insurance.

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Re: Do we need irrevocable life insurance trust (ILIT)?

Post by Theoretical » Tue Mar 24, 2015 10:59 pm

Ditto to bsteiner. Thanks for mentioning the state estate tax issue. That can be a nasty surprise, even if you don't live in the state but do own property there (like a vacation home).

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