Spousal Access Trusts Access To Cash Value Potential Through Flexible Trust Planning

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1 SALES STRATEGY Guiding you through life. ESTATE PLANNING Spousal Access Trusts Access To Cash Value Potential Through Flexible Trust Planning The Concerns Many clients who are concerned about maximizing the amount left for their heirs know that one of the best ways to transfer wealth is through an Irrevocable Life Insurance Trust (ILIT). However, these same clients may put off creating and funding an ILIT because they are concerned about flexibility. They do not want to lose access to assets they have put into the ILIT for a variety of reasons: in case they need the money later to live on, if their financial circumstances change, or if the current tax environment changes. How can you help these clients plan for the future while maintaining flexibility in the face of uncertain times? A Spousal Access Trust may be able to help. The Solution A Spousal Access Trust is a type of ILIT that enables the spouse of the trust grantor to receive distributions from the trust during his/her lifetime. A Spousal Access Trust names the spouse of the grantor, in addition to the children of the grantor, as the trust beneficiaries, and can be used with either a single life or a survivorship life insurance policy. How It Works A Spousal Access Trust functions very much like a traditional ILIT. An ILIT is an irrevocable trust that is the owner and beneficiary of one or more life insurance contracts, and keeps the insurance proceeds outside of the taxable estate. An ILIT cannot be revoked, altered or amended by the grantor (i.e., the party creating the ILIT), and the trust beneficiaries are typically the children and grandchildren of the grantor. The grantor usually makes annual contributions to the ILIT to fund premiums, and these gifts can avoid gift tax by giving the trust beneficiaries a power to withdraw contributions made to the ILIT. These powers of withdrawal, known as Crummey powers, cause the contributions to the ILIT to be present interest gifts that qualify for the annual exclusion from gift tax. The annual exclusion is currently $14,000 per person and will be indexed for inflation based on increases in the Consumer Price Index (CPI). In addition to the annual exclusion, the American Taxpayer Relief Act of 2012, enacted a permanent set of estate, gift, and generationskipping transfer (GST) tax provisions with the exemption for gift, estate and GST tax purposes set at $5 million, indexed for inflation. A Spousal Access Trust differs from a traditional ILIT in that a Spousal Access Trust enables the spouse of the trust grantor to receive distributions from the trust during his/her lifetime. A Spousal Access Trust names the spouse of the grantor, in addition to the children of the grantor, as the trust beneficiaries. A Spousal Access Trust can be used with either a single life or a survivorship life insurance policy, and it will also have the tax benefits of a traditional ILIT. Benefits Distributions During Insured s Life. With a Spousal Access Trust, the trustee can make distributions to the grantor s spouse and children during the insured s lifetime, if necessary, for their health, education, maintenance and support. Alternatively, an independent trustee may have absolute discretion to make distributions to the beneficiaries. Access to the Policy s Cash Value. By allowing distributions to the spouse and children during the grantor s lifetime, the family has not given up tax-favorable access to the potential cash value of the life insurance policy. Page 1 of 5. Not valid without all pages.

2 Tax-Free Death Benefit Available for Spouse or Children. The ILIT will receive the death benefit free from both income and estate taxes. The death benefit can provide liquidity to pay estate taxes and other costs of estate administration as well as provide estate equalization. Spouse or Children as Trustees. With a single life insurance policy in a Spousal Access Trust, either the spouse or adult children of the insured/grantor can be trustees of the ILIT. However, with a survivorship life insurance policy and a Spousal Access Trust, for estate tax reasons, neither of the spouses can be a trustee since both of them are insureds. In a survivorship situation, one of the insureds will be the grantor of the trust and the other one will be the beneficiary (usually the spouse with the longer life expectancy). Adult children of the insureds can be trustees in a Survivorship Spousal Access Trust, or the grantor can choose another trusted person to serve as trustee. Considerations Irrevocable Transfers. Transfers to an ILIT are irrevocable and may only be used for the benefit of trust beneficiaries. Proper Planning. Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including the generation-skipping transfer tax). Failure to do so could result in adverse tax treatment of trust proceeds. Policy Performance is Not Guaranteed. The policy s cash value available for loans and withdrawals may be worth more or less than the original investment amount, depending on the performance of the policy. Withdrawals are available in the second policy year. Avoid Creating a MEC. Policies classified as MECs may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age 59½. Death Benefit Reduction. Withdrawals and loans can reduce the policy death benefit and cash surrender value and may cause the policy to lapse. Lapse of a life insurance policy can cause the loss of the death benefit and potential adverse income tax consequences. Policy Charges. Life insurance policies have charges associated with them, including withdrawal and cost of insurance charges. Single Life Strategy A single life insurance policy is often purchased to protect a primary income earner s family against his or her premature death. Such policies are often owned outright by the insured or the insured s spouse. However, outright ownership of a life insurance policy causes the death benefit to be subject to estate taxes. A Spousal Access Trust can keep the policy outside of the insured s taxable estate while still allowing the insured s spouse to access the policy s cash value. Page 2 of 5. Not valid without all pages.

3 Year Annual Premium CASE STUDY: ROBERT AND ANN SCHULTZ Robert Schultz (age 45, male, Non Smoker Preferred, Massachusetts resident) has a dilemma. He needs about $1.5M of life insurance to protect his wife Ann (age 42) and his three children in the event of his death. Since he is contributing fully to his 401(k) plan and wants to save more for retirement, Robert was hoping to use one insurance policy to solve both needs by purchasing a $1.5M policy and funding it with enough money to provide supplemental retirement income. However, if he owns the policy himself, the death proceeds could one day be subject to estate taxes. The Spousal Access Trust can provide a solution to Robert s dilemma. Robert can make annual exclusion gifts of about $39,000 a year to a Spousal Access Trust. The trust will purchase an indexed-ul type universal life policy on Robert s life with a face amount of about $1.5M and will fund the policy with premiums of about $39,000 for 20 years. Ann will be the trustee during her life. If anything should happen to Robert today, Ann and the children would be protected by the death benefit. However, during Robert s lifetime, the trustee could also use the policy s cash value to make distributions to Ann and the children for their health, education, maintenance and support. By the time Robert retires in 20 years at age 65, the policy s cash value is projected to be about $1.3M based on assumed interest crediting rate of 7.75% and current cost of insurance charges. Starting in year 21, the trustee could make distributions of around $100,000 a year from the policy for 35 years, if needed, for the benefit of Ann and the children. These hypothetical projected distributions represent withdrawals up to the policy basis and loans thereafter up to the maximum cash surrender value. By using a Spousal Access Trust, Robert and Ann are able to protect their family but still have access to the policy s potential cash value in case of an emergency. Approximate Annual Distribution to Beneficiaries Approximate Cash Value Approximate Death Benefit Net of Loans/ Withdrawals 1 39, ,500, , ,000 1,900, , ,330,000 2,700, ,000 1,190,000 1,680, , ,000 1,120,000 The figures used in this case study are hypothetical, for discussion purposes only, are not guaranteed and may not be used to project or predict results. Actual results may be more or less favorable. Specific product and policy elements would be found in a policy illustration provided by an insurer. With any decision regarding the purchase of life insurance, a client would need to determine which type of life insurance product is most suitable for their specific needs. The hypothetical rate of return in the above example is based on an allocation of premiums to an indexed account that credits interest based on the changes in an underlying index and is not indicative of future results. The net premium in the example is allocated to the Capped Indexed Account that credits up to 13% and has a floor of 0%. The hypothetical average annual rate of return assumed for the Capped Indexed Account is 7.75%. Survivorship Strategy Survivorship ILITs are a popular estate planning tool because survivorship life insurance is usually less expensive than single life coverage. And, because of the unlimited marital deduction from estate tax, most couples will not owe an estate tax until the death of the surviving spouse. A concern sometimes raised with Survivorship ILITs is that retaining access to the policy s cash value is often considered impossible. By using a special type of Survivorship ILIT, known as Survivorship Spousal Access Trust, one of the spouses can retain access to the cash value during his or her life as a trust beneficiary. As long as the trust is properly drafted and administered, the trustee can make distributions to the beneficiary spouse and to the children during their lifetimes. 1 Page 3 of 5. Not valid without all pages.

4 CASE STUDY: BRIAN AND ANDREA MCCOY Brian McCoy (age 55, Massachusetts resident) and his wife Andrea (age 52) are both Preferred Non Smokers. They know that they need to start planning for their estate, and will likely need life insurance to help pay their estate taxes. However, they are concerned about putting money in an ILIT where they can no longer access it. Although they are doing very well financially, they are still many years from retirement. They have seen their investment portfolio grow and shrink many times with the ups and downs of the stock market. While Brian and Andrea don t expect that they ll ever need to touch the insurance policy, they want to have access to the policy in case of a financial crisis. A Survivorship Spousal Access Trust can help in this type of situation. Brian, as the grantor, will create a Survivorship Spousal Access Trust and fund it with $25,000 of annual exclusion gifts. 2 Andrea and their two children will be the beneficiaries of the trust, which will purchase a current assumption survivorship UL contract with a face amount of about $2.1M on Brian and Andrea with a premium of about $25,000 payable for 10 years. At Brian s retirement age of 65, the policy is projected to have a cash value of about $210,000 and if the McCoy s face a financial emergency, the trustee could make distributions from the policy s cash value for Andrea and their children. In this way, the McCoy s can provide funding inside of their trust to pay for estate liquidity needs while still having access to the policy s cash value in case of an emergency. The figures used in this case study are hypothetical and are provided for discussion purposes only. The Authority Incidents of Ownership. Because the insured(s) do not retain any interest in the Spousal Access Trust, the death benefit should not be included in his or her taxable estate. 3 The family s control is derived from the spouse s rights in the trust and the IRS does not attribute incidents of ownership held by a non-insured spouse to an insured spouse. 4 General Power of Appointment. Assets held in trust for a spouse are not necessarily included in the spouse s estate. A common example of this is a credit shelter trust (or by-pass trust). Property can be kept out of a surviving spouse s estate by not giving the surviving spouse a general power of appointment. The Internal Revenue Code specifically provides that the beneficiary of a trust (including a surviving spouse) can be given the right to receive distributions subject to an ascertainable standard, such as health, education, maintenance, and support. 5 Powers Exercisable in a Fiduciary Capacity. Trust assets are not ordinarily included in a trustee s gross estate. This is true even if the trustee is a beneficiary of the trust. A credit shelter trust is a common example of this. To avoid estate tax inclusion, the spouse s power to make distributions to himself or herself must be limited to an ascertainable standard in a Single Life Spousal Access Trust document. Gifts with a Retained Interest. In a single life situation, only the insured spouse will be a grantor of the trust, and he/she will not have a retained interest in the trust. 6 For estate tax purposes, in either a single life or a survivorship situation, only the grantor spouse can make gifts to the trust, although the non-grantor spouse can gift-split with the grantor spouse. Private Letter Ruling (PLR) demonstrates how the concept of a Survivorship Spousal Access Trust works. 7 SUMMARY Married couples can create single life or survivorship ILITs for a variety of estate planning purposes. A Spousal Access Trust can make ILITs more flexible by providing access to the life insurance policy s cash value for the family s lifetime needs while still keeping the death benefit outside of the taxable estate. A Spousal Access Trust can also provide non-tax benefits, such as creditor protection for the beneficiaries and professional management of trust assets. Variable life insurance products, with the potential for high cash value accumulation inside of the policy, can be an excellent choice for funding a Spousal Access Trust. Page 4 of 5. Not valid without all pages.

5 For more information, please contact your local John Hancock representative or call the Group at , option 3. 1 To avoid giving the beneficiary spouse any incidents of ownership with a Survivorship Spousal Access Trust, the authority to make distributions to the surviving spouse may need to be limited to an independent trustee with absolute discretion. See PLR If Brian predeceases Andrea, his estate plan (will or revocable trust) should leave an amount to the Survivorship Spousal Access Trust at least equal to his remaining applicable exclusion amount. 3 Whether the proceeds of a life insurance contract are included in the gross estate of the insured depends upon whether, at the time of death (or within the three-year period prior to death) the insured held any incidents of ownership with respect to the policy. IRC S 2042 and 2035(d)(2). For both a Single Life and a Survivorship Spousal Access Trust, the beneficiary spouse should not be given Crummey rights of withdrawal. 4 In a community property state, the premium gifts to the ILIT should be funded from separate property. See Treas. Reg (b)(2). 5 IRC 2041(b)(1)(A). 6 See IRC Section PLRs are merely an IRS interpretation of law and are binding only upon the taxpayers to whom they are issued. For Financial Services Professional Use Only. Not For Use With The General Public. This material does not constitute tax, legal or accounting advice and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It was not intended or written for use and cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Comments on taxation are based on John Hancock s understanding of current tax law, which is subject to change. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors. Product and features may not be available in all states. Guaranteed product features are dependent upon minimum premium requirements and the claims-paying ability of the issuer. INSURANCE PRODUCTS: Insurance products are issued by: John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in New York) and John Hancock Life Insurance Company of New York, Valhalla, NY John Hancock. All rights reserved. Not a Deposit Availability for distribution subject to State approval. IM7038 MLINY /13 Scan this code to find out more. Not FDIC Insured Not Bank Guaranteed May Lose Value Not Insured by Any Government Agency Page 5 of 5. Not valid without all pages.