Life Insurance and Estate Planning

Transcription

1 CHAPTER 12 Life Insurance and Estate Planning Aaron J. Goldberg, Esq. Law Firm of Aaron J. Goldberg, PLC, Elder Law & Trust Group, Burlington 12.1 Introduction Gross Estate Taxation (as of 2014) Vermont Statutory Legislation Vermont Statutes Annotated Protection from Creditors (a) 8 V.S.A Spendthrift Provisions; Creditors of Beneficiary (b) 8 V.S.A Exemption of Proceeds Life Insurance (c) 8 V.S.A Trust Agreements (d) V.S.A Assignment of Insurance Policies or Annuity Contracts Federal Regulation Vermont State Regulation Client Meeting and Investigation Needs Analysis Durable Powers of Attorney Sample POA Language with Different Options for Insurance Policies Relating to Change of Ownership and Beneficiaries Trusts Analysis i

2 ESTATE PLANNING IN VERMONT Creditors of Insured Tax Planning Three-Year Rule and Incidents of Ownership Planning with a Spouse and Children State and Federal Estate Tax Return Issues Children as Beneficiaries Irrevocable Life Insurance Trust Minor Children Present Gifts Crummey Provisions Incidents of Ownership Gift Tax Concerns Vermont Long-Term Care Planning and Medicaid Planning Vermont Medicaid Rules Choices for Care Long-Term Care Medicaid Special Needs Trusts for Adults or Children with Disabilities (a) First-Party Supplemental Needs Trust with Payback Provision (b) Third-Party Supplemental Needs Trust Fraud Issues Impacting Estate Planning EXHIBIT 12A Supplemental Materials EXHIBIT 12B Information on Life Insurance Excerpted from the Vermont Department of Financial Regulation Website EXHIBIT 12C Disclosure Relating to Insurance in Engagement Letter ii

3 CHAPTER 12 Life Insurance and Estate Planning Aaron J. Goldberg, Esq. Law Firm of Aaron J. Goldberg, PLC, Elder Law & Trust Group, Burlington Scope Note This chapter provides an introduction to the use of life insurance in completing a client s estate plan. It provides the reader with practical pointers on researching information, such as that which is available on the IRS website. It covers gross estate taxation, Vermont statutory legislation and state regulation, as well as federal regulation. It offers tips on the client meeting and investigation, and addresses such tools as the durable power of attorney INTRODUCTION Before beginning a general discussion of the use of life insurance in estate planning, it is important to explain where an estate planning attorney can access information about life insurance and the regulation of life insurance products. The following information is meant as a guide; it is not inclusive of every reference source. This chapter will provide starting points for an analysis of the use of life insurance in completing an estate plan with a client and will allow you to give clients tips on researching information themselves. The IRS maintains a website at which is a starting place for tax issues surrounding the topic of life insurance. While certain sections of the Internal Revenue Code and the Code of Federal Regulations are included in Exhibit 12A, all federal insurance regulations, Treasury Regulations, Internal Revenue Code sections, Code of Federal Regulations, Technical Advisory Memoranda, Private Letter Rulings, and Treasury Regulations relating to life insurance are not included in this chapter. The federal statutes relating to taxation of life insurance are included in Exhibit 12A. (With regard to I.R.C. 2056, the sections related to Generation Skipping Transfer Taxation and state or federal taxation of such transfers are not included in this chapter.) The State of Vermont has statutory authority on the 12 1

4 12.1 ESTATE PLANNING IN VERMONT subject of life insurance, and certain statutes, but not all, are cited. None of the Vermont state statutes addressing the taxation of life insurance are included herein. The State of Vermont also has a regulatory department that oversees life insurance, called the Vermont Department of Financial Regulation. Again, certain Vermont regulatory sections are cited for the use of the reader, but only as a guide. Every life insurance company maintains its own website; this chapter does not draw upon those resources. Nor does it draw upon web-based sites that compare policies, of which there are many GROSS ESTATE TAXATION (AS OF 2014) The federal limit before an estate is taxed is $5.34 million. This is a portable exemption amount, meaning that each member spouse has this available credit, so if one spouse does not use his or her credit at his or her death, the survivor can shelter $10.78 million from federal estate tax. Note that the estate tax exemption is the same for lifetime gifts at the same level. Be advised that as of January 1, 2011, for Vermont estate tax purposes, Vermont is no longer tied to the federal system. This means that the State of Vermont will tax any estate that is more than $2.75 million, even when there is no federal estate tax. Vermont imposes a tax on the transfer of the Vermont estates of resident and nonresident decedents. Where a decedent was a resident of Vermont at the time of death, the Vermont estate tax may apply if the federal gross estate exceeds $2.75 million on the date of death or if the estate is required to file a federal estate tax return. The valuation of the gross estate will include the value of life insurance policies. Where a decedent was a nonresident of Vermont, the estate still may be subject to the Vermont estate tax if it includes real or personal property located in Vermont and the federal gross estate exceeds $2.75 million on the date of death or if the estate is required to file a federal estate tax return VERMONT STATUTORY LEGISLATION The sections of the Vermont Statutes relating to state taxation are not included herein. More information on Vermont estate taxes can be found on the Vermont Department of Taxes website at The Vermont Statutes Annotated address life insurance in Title 8, Chapter 103, which is available at

5 LIFE INSURANCE 12.3 &Chapter=103. This information is useful in order to integrate life insurance into estate planning. Particular sections are included herein for discussion VERMONT STATUTES ANNOTATED The Vermont Statutes address life insurance in the context of creditors Protection from Creditors For estate planning purposes, Vermont law protects a spendthrift trust for a beneficiary and protects the beneficiary from creditors to the extent that a life insurance policy is intended for the benefit of either one. 8 V.S.A. c (a) 8 V.S.A Spendthrift Provisions; Creditors of Beneficiary When a contract of annuity, a policy of insurance, or other contract of a life insurance company authorized to do business in this state is entered into with any person for the benefit of another, and such contract so provides, a beneficiary entitled to any of the proceeds retained thereunder by such company or to interest thereon shall not be permitted to commute, anticipate, encumber, alienate, or assign the principal or interest thereon, or any part thereof, nor, if such contract so provides, shall any part of such principal or interest be subject to the claims of creditors of any such beneficiary, nor be in any way subject to such beneficiary s debts, contracts, or engagements, or to any judicial process to levy upon or attach such proceeds for payment of such claims or demands. Contracts so providing shall be valid and enforceable. Further, a life insurance policy cannot be reached by the creditors of the owner of the policy, whether the policy is on his or her own life or on another life. Nor can creditors reach the funds after they have been distributed to the recipients under the policy, regardless as to whether the recipient was an assignee or a beneficiary. This is the case even where the original owner reserved the right to change beneficiaries. The exception is where actions were taken to defraud creditors; in such cases, the amount of any premiums paid with intent to defraud creditors, plus interest, inures to the benefit of the creditor and derives from the proceeds of the policy. 12 3

6 12.4 ESTATE PLANNING IN VERMONT (b) 8 V.S.A Exemption of Proceeds Life Insurance (a) If a policy of insurance, whether heretofore or hereafter issued, is effected by any person on his or her own life, or on another life, in favor of a person other than himself or herself, or, except in cases of transfer with intent to defraud creditors, if a policy of life insurance is assigned or in any way made payable to any such person, the lawful beneficiary or assignee thereof, other than the insured or the person so effecting such insurance or executors or administrators of such insured or the person so effecting such insurance, shall be entitled to its proceeds and avails against the creditors and representatives of the insured and of the person effecting the same, whether or not the right to change the beneficiary is reserved or permitted, and whether or not the policy is made payable to the person whose life is insured if the beneficiary or assignee shall predecease such person, and such proceeds and avails shall be exempt from all liability for any debt of the beneficiary existing at the time the policy is made available for his or her use: Provided, that subject to the statute of limitations, the amount of any premiums for such insurance paid with intent to defraud creditors, with interest thereon, shall inure to their benefit from the proceeds of the policy; but the insurer issuing the policy shall be discharged of all liability thereon by payment of its proceeds in accordance with its terms, unless, before such payment, the insurer shall have received written notice at its home office, by or in behalf of a creditor, of a claim to recover for transfer made or premiums paid with intent to defraud creditors, with specification of the amount claimed along with such facts as will assist the insurer to identify the particular policy. (b) For the purposes of subsection (a) of this section, a policy shall also be deemed to be payable to a person other than the insured if and to the extent that a facility-of-payment clause or similar clause in the policy permits the insurer to discharge its obligation after the death of the individual insured by paying the death benefits to a person as permitted by such clause. 12 4

7 LIFE INSURANCE 12.4 The Vermont Statutes also address life insurance and annuity contracts. They allow such policies to be owned by trusts, and to be assigned. (c) 8 V.S.A Trust Agreements A life insurance company chartered by and doing business in this state shall have power and authority to hold in trust or otherwise the proceeds of any life insurance policy or annuity issued by it upon such terms and subject to such conditions and limitations as may be agreed upon in writing by such company and the owner of the policy or the purchaser of the annuity. The contract, policy, or trust instrument may provide that no payments of interest or of principal shall be in any way subject to the claims of the creditors of the person entitled to any part of the proceeds so held or to his debts, contracts, or engagements, or to any judicial process to levy upon or attach such proceeds for payment of such claims or demands, and that the person entitled to any of the proceeds so held shall not be permitted to commute, anticipate, encumber, alienate, or assign the same or any part thereof or the interest thereon. Such life insurance company shall not be required to segregate the funds so held but may hold them as a part of its general corporate assets. Nothing in this section or in the trust or other provisions herein contemplated shall subject such life insurance company to the provisions of the law of this state relative to banks or trust companies. (d) V.S.A Assignment of Insurance Policies or Annuity Contracts (a) A policy of insurance or an annuity contract may be assignable or not assignable, as provided by its terms. Subject to its terms relating to assignability, any such policy or contract, whether heretofore or hereafter issued, under the terms of which the beneficiary may be changed upon the sole request of the insured or owner, may be assigned either by pledge or transfer of title, by an assignment executed by the insured or owner alone and delivered to the insurer, 12 5

8 12.4 ESTATE PLANNING IN VERMONT whether or not the pledgee or assignee is the insurer. Any such assignment shall entitle the insurer to deal with the assignee as the owner or pledgee of the policy or contract in accordance with the terms of the assignment, until the insurer has received at its home office written notice of termination of the assignment or pledge, or written notice by or on behalf of some other person claiming some interest in the policy or contract in conflict with the assignment. (b) Notwithstanding any provision of law, a person whose life is insured under any policy of group life insurance may make an assignment of all or any part of his or her incidents of ownership in the insurance, including, without limitation, any right to designate a beneficiary or beneficiaries thereunder and any right to have an individual policy issued in lieu of such group insurance coverage upon termination either of employment or of the policy of group life insurance, provided that the insurer and the group policy holder may prohibit or restrict such an assignment by appropriate policy provisions FEDERAL REGULATION The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 established the U.S. Department of the Treasury s Federal Insurance Office (FIO) and vested it with the authority to monitor all aspects of the insurance sector. It also created the federal Consumer Financial Protection Bureau (CFPB), which also has rule-making authority relating to life insurance. The CFPB s website can be found at According to the office, it has not promulgated regulations, but does take complaints. The Code of Federal Regulations includes regulations relating to life insurance that are part of the truth-in-lending regulations, as part of the Appendix Supplement I to Part 1026, Official Interpretations, Paragraphs 4(b)(7) and (b)(8), which are included in Exhibit 12A VERMONT STATE REGULATION The Vermont Department of Financial Regulation regulates the sale of life insurance products in Vermont. Its website, which can be found at

9 LIFE INSURANCE 12.6.vermont.gov/, is filled with important information for attorneys and their clients, including the mortality tables for life insurance and annuity products, which are located at There is another page for the rules and orders issued by the Department, which can be found at _regbul_value=reg. A sample page from the website relating to the types of policies, how to file complaints, how to utilize a free view of a policy, how to choose a company, how to check company ratings, and the licensing status of agents is included as Exhibit 12B. Practice Note Your retainer letter, or a separate letter, should indicate that the attorney is not taking on the responsibility of choosing a policy, evaluating the ratings of a company, or selecting an agent. If you are recommending an agent, you should let the client know by separate letter or that he or she has the right to choose another agent, and that you are relying on the agent to choose the best product for the client. Finally, your disclosure needs to state that the final decision is the client s, unless you are willing to undertake the analysis of the agent, the company ratings, and the actual policy as part of your attorney-client due diligence requirements. Rule 1.1 of the Vermont Rules of Professional Conduct requires that a lawyer provide competent representation to the client: A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation. Comment 6 to Rule 1.2 of the Vermont Rules of Professional Conduct, Scope of Representation and Allocation of Authority Between Client and Lawyer, states as follows: The scope of services to be provided by a lawyer may be limited by agreement with the client or by the terms under which the lawyer s services are made available to the client. When a lawyer has been retained by an insurer to represent an insured, for example, the representation may be limited to matters related to the insurance coverage. A limited representation may be appropriate because the client has limited objectives for the representation. In addition, the terms upon which representation is undertaken may 12 7

10 12.6 ESTATE PLANNING IN VERMONT exclude specific means that might otherwise be used to accomplish the client s objectives. Such limitations may exclude actions that the client thinks are too costly or that the lawyer regards as repugnant or imprudent. Rule 1.3 of the Vermont Rules of Professional Conduct states as follows: A lawyer shall act with reasonable diligence and promptness in representing a client. The same Professional Responsibility Board (PRB) rule implicitly suggests that an engagement letter make certain that the lawyer detail what the attorney will be doing so there is no misunderstanding as to the client s expectations. See PRB Rule 28 (2001). See also Exhibit 12C. Reasonable measures, such as engagement letters, should be utilized to ensure that those engaging an attorney s services are not misled. Vermont Bar Ass n, Advisory Ethics Op (licensed attorney not doing legal services). The burden is upon the lawyer to show that the lawyer has taken reasonable measures under the circumstances to communicate the desired understanding. For instance, a sophisticated user of law-related services, such as a publicly held corporation, may require a lesser explanation than someone unaccustomed to making distinctions between legal services and law-related services, such as an individual seeking tax advice from a lawyer-accountant or investigative services in connection with a lawsuit. Vermont Bar Ass n, Advisory Ethics Op CLIENT MEETING AND INVESTIGATION When meeting with clients, it is vital for the estate planner to determine their assets for state and federal taxability issues. This includes a review of their insurance policies, as well as debts, other assets, income and long-term care concerns. The insurance analysis should include the following information: the issuing company; the policy limits: the type of policy; 12 8

11 LIFE INSURANCE 12.7 the current annual cost; the current year of the policy and its projected cost; term or whole life cost and its projected cost; conversion rights, including whether there is a need for a medical exam; the clients current medical condition; the owner of the policy, including an individual, joint owners, or a revocable or irrevocable trust; the beneficiaries; the clients asset and income information if additional coverage is needed; the cash value and surrender value of existing policies; and the clients ages to obtain quotes or to refer to agents. The following questions should also be asked of clients: Is it the first marriage or second marriage for the clients? Are there minor children of the current marriage or prior marriage? Is there a trust for the minor children? If so, what are the purposes of the trust and who is the current trustee and designated successor trustee? Is there a court-ordered obligation to maintain insurance. If so, for whom and to what age? For a business, is there a key-person life insurance policy or a policy that is tied to a business buyout agreement? Is there a need to fund a trust for a child who is need of a spendthrift trust? Is there a need to fund a third-party supplemental needs trust, meaning a trust funded with insurance purchased by the parent or grandparent or a third party for the benefit of a child with special needs who is receiving state or federal benefits? 12 9

12 12.7 ESTATE PLANNING IN VERMONT Needs Analysis The investigation stage of your intake with the client should consider and then determine the need for life insurance. This analysis is an exchange between the attorney and the client to determine the rationale for keeping existing policies or the need to obtain additional coverage. In addition to reviewing the client s assets and liabilities, it is useful to put together a budget with the client, whether the client is single, with a partner, or married. What will the survivor s income be and what will the debts be? Depending on his or her age, how will the survivor s income change with Social Security or retirement benefits? How will the survivor manage the debt? Are income-producing assets in joint names? If not, who are the beneficiaries? This issue deserves more attention in second marriages. Life insurance can be used as a tool to fix many anticipated problems or projected issues. It also assures that the life insurance proceeds, in cash, will be accessible to the party who needs it to manage the problem. The following is a list of planning ideas that may be discussed. Life insurance may be in place, or may be needed, for the following reasons: The client may need life insurance to replace the wage-earning power of the person in the household earning the most income. This is particularly important where the insured has a spouse or partner and minor children. The client may need life insurance to pay for the cost of replacing the caregiver of the minor children if the caregiver deceases. This does not necessarily mean that the policy limits are the same. A couple may decide that they need more insurance on the caregiver, so that if the caregiver deceases, the primary income earner does not need to work but can be the caregiver, having received the proceeds of the policy. Alternatively, the primary wage earner may wish to continue working, but have sufficient life insurance on the life of the caregiver to make certain that there are sufficient funds available to pay for caregiving services in the event of the caregiver s death. The client may want insurance to be received by the surviving spouse or partner to pay off existing mortgages. The client may desire insurance to be received by lineal heirs to pay for estate taxes. There may be a need for liquid cash to be received to pay other installment debts other than a mortgage

13 LIFE INSURANCE 12.7 There may be a need for cash to support the decedent s family. Such support, especially where the survivor has limited income and assets, may include the costs of the mortgage, real property taxes, utilities, house and car insurance, car maintenance, private school tuition, and college or university education. If a probate estate is needed, there may be legal expenses. If there are state or federal estate taxes, there may be legal expenses, and there will most likely be accounting expenses. The client may desire to make a gift to charity through the use of insurance. A business may need a key-person life insurance policy to make certain that funds are available to hire a successor. A business may need life insurance policies on the business owners to fund a buyout agreement in the event of the death of one of the owners. While not addressed here, the buyout agreement should contemplate disability insurance in the event of the disability or incapacity of one of the business owners. Where there is a family-owned business and the client has children, insurance is a tool to utilize and make unequal beneficiaries. An example is where the client desires that one or more children who are active in the family business receive the actual business assets and noninvolved children receive additional life insurance proceeds in lieu of a share in the family business. Utilizing life insurance as a tool can avoid litigation between the children who are active in the business and the children who are not. Given the Vermont estate tax on estates that are at $2.75 million and the portability of the federal estate and gift tax exclusion for spouses, counsel needs to be concerned with obtaining life insurance liquidity to cover taxes at the death of the first spouse in Vermont where there is a taxable estate in Vermont, and the second spouse if the combined estates are over the federal limit of $10.34 million in Depending on the client s age, medical condition, and income, a cost-basis analysis needs to be done. This may include, but not be limited to 12 11

14 12.7 ESTATE PLANNING IN VERMONT whether new term policies should be purchased that are cheaper; whether cash value in policies should be utilized to purchase additional insurance within a policy or another policy; whether certain types of policies should be utilized instead of others, for instance, variable life means that the death benefit is tied to market conditions, whereas term life is not, and neither is universal life or whole life. The death benefits are guaranteed with term life, universal life, and whole life. A client with variable life may not even realize the death benefit for this product is tied to market conditions and is not guaranteed; and depending on the client s age, and whether there is a need to funds due to the death of the parent for a spouse, partner, or minor children, whether funds currently being used to pay for life insurance should be rededicated for long-term care insurance. This will also depend on the scope of the client s assets and requires an analysis of the Vermont Choices for Care Long-Term Care Medicaid resource limits. Practice Note Remember, if you are representing a couple, your engagement letter should include language that you represent both of them, cannot represent one against the other, and that you are under a duty to share information that one party informs you of with the other party DURABLE POWERS OF ATTORNEY Many insurance companies and investment companies want to review powers of attorney to see if the agent has the explicit power to change the ownership of policies or the beneficiaries, including removing or adding the agent, siblings, or their spouses or other third parties. Your client may wish to add such a power to a durable power of attorney. Alternatively, your client may want to limit this power or make it explicit as to this clause if the principal desires to impose restrictions. (The same issues need to be raised with a client as to whether an agent should have the explicit power to amend or revoke a trust.) Practice Note Regardless of which powers your client desires to insert in a power of attorney, you may decide to have him or her initial the paragraph

15 LIFE INSURANCE 12.8 to indicate that you reviewed the power of attorney insurance clause with him or her. Alternatively, you may decide to have an additional clause in the power of attorney confirming that counsel has explained all clauses in the power of attorney to the client and that the client understands the entire document and has no questions concerning any of the powers granted by the client, as principal, to the designated agent Sample POA Language with Different Options for Insurance Policies Relating to Change of Ownership and Beneficiaries My Agent is specifically prohibited from changing the ownership or beneficiaries of any life insurance contract, which I own, whether owned by me individually or as Trustee. My Agent is specifically authorized to change the ownership of any life insurance policies which I own, whether owned by me individually or as Trustee, and designating the owner as my spouse, or my children, including my Agent, without limitation. Practice Note The above provision may be useful if you need to change the ownership of a policy from an ill spouse in order for the cash value to be counted as a resource to the well spouse for Choices for Care Long- Term Care Medicaid resource planning purposes. My Agent is also specifically authorized to change beneficiaries on any life insurance policies which I own, including designating the Agent as a primary beneficiary, along with the Agent s spouse, siblings, and their spouses, per stirpes, and any third parties, without limitation. My agent is also specifically authorized to change beneficiaries on any life insurance policies which I own, including making the Agent a primary beneficiary, per stirpes, so long as the Agent also includes all of the Agent s siblings as equal primary beneficiaries, per stirpes, or the Trustees of any trust established for their benefit, if required to maintain any beneficiary s state or federal benefits, and including the spouses of beneficiaries as contingent beneficiaries of each respective child

16 12.8 ESTATE PLANNING IN VERMONT My agent is also specifically authorized to change beneficiaries on any life insurance policies which I own, including making the Agent a primary beneficiary, per stirpes, so long as the Agent also includes all of the Agent s siblings as equal primary beneficiaries, per stirpes, or the Trustees of any trust established for their benefit, if required to maintain any beneficiary s state or federal public benefits, and excluding the spouses of beneficiaries as contingent beneficiaries of each respective child TRUSTS ANALYSIS If there is a trust involved, titling of the policy needs to be reviewed. If there is an irrevocable life insurance trust involved, further questions should be posed to determine whether the clients are improperly exercising incidents of ownership over the policy, to be discussed further, such that the policy will be included in the clients gross state or federal taxable estate or be countable as a longterm care countable resource against the client CREDITORS OF INSURED As noted above in 8 V.S.A. 3706, the insurance proceeds received by a spouse or children are not reachable by the creditors of the insured. Life insurance received by the spouse or children will be protected if it is replacing wages of a deceased wage earner or is needed to cover the family s ongoing expenses TAX PLANNING The life insurance policy proceeds are included in the calculation of the decedent s state and/or federal gross estate for estate tax purposes. This is the case when the policy is payable to the spouse, children, or estate of the decedent. Counsel must be aware that the total life insurance can add significant amounts to the gross estate of the insured and the surviving spouse or partner, and that the total can be above the applicable state or federal exclusion amount

17 LIFE INSURANCE THREE-YEAR RULE AND INCIDENTS OF OWNERSHIP Life insurance policy proceeds are also included in the calculation of the decedent s state and/or federal gross estate for estate tax purposes. This is also the case if the insured decedent held any incidents of ownership over the policy at the death of the insured decedent or purchased the policy and then transferred any incidents of ownership within the three-year period prior to the death of the insured. The following sections of the Internal Revenue Code apply to several scenarios, such as where the insured owned life insurance on another person, I.R.C. 2033; the insured purchased a life insurance within the three-year period prior to death and attempted to transfer it, I.R.C. 2035; the insured is not the decedent, but another person, so the insurance policy insures the life of a third party, I.R.C. 2035(d); or the insured has life insurance policies involving a transfer by an insured to a third party where the insured decedent retained rights over the policy, I.R.C Finally, the life insurance proceeds are included in the calculation of the decedent s state and/or federal gross estate for estate tax purposes where the insured decedent has a policy or policies that are paid to the insured decedent s estate representative. I.R.C. 2042(1) PLANNING WITH A SPOUSE AND CHILDREN Where counsel is presented with a married couple, life insurance can be utilized to make sure that the surviving spouse has sufficient principal and income. In the event that the insured dies first, then estate taxes will be avoided by the use of the unlimited marital deduction. For gift tax purposes, a transfer of a life insurance policy between spouses is not taxable. If the life insurance proceeds do not qualify for the unlimited marital deduction, the proceeds will be deemed to be a nondeductible terminable interest. To qualify an insurance policy for the unlimited marital deduction, the policy proceeds payout must meet the elements declared by the terms of I.R.C. 2056(b): 12 15

18 12.13 ESTATE PLANNING IN VERMONT the proceeds must be payable only to the spouse, I.R.C. 2056(b)(1)(A); upon the death of the spouse, the proceeds then must be payable to the spouse s estate, I.R.C. 2056(b)(1)(A); the payments from an insurance policy, endowment policy, or annuity policy, to the spouse must start within thirteen months of the death of the insured decedent, I.R.C. 2056(b)(6); and only the surviving spouse can possess a general power of appointment over the policy proceeds, I.R.C. 2056(b)(5), (7) STATE AND FEDERAL ESTATE TAX RETURN ISSUES In the event counsel is planning to utilize common A-B trust planning in an attempt to reduce taxes, this may be difficult since a Vermont death tax may still be due on the B trust after the death of the first spouse, even though there may be no federal estate tax. This is because of the gap between the Vermont exemption and the federal exemption amount, noted above. Vermont has not yet formally recognized the right by the married decedent s estate to make an election to treat a trust of which the surviving spouse is the sole beneficiary as qualified terminable interest property (QTIP) for purposes of calculating the Vermont tax. Practice Note Check with the Vermont Department of Taxes and a certified public accountant about taking the QTIP election. Counsel can orchestrate the funding of the credit-shelter trust with an insurance policy up to the amount of the unified credit exemption by naming the trust as a beneficiary. Assuming the couple s assets are then split in terms of individual ownership between the spouses and valued at the current exemption limit, then the balance of the estate is then transferred to the surviving spouse using the unlimited marital deduction. This can be done by a transfer in trust to the surviving spouse or by an outright transfer to the surviving spouse. At the death of the first spouse, the full amount of the credit exemption will then transfer into the survivor s estate tax free. At the death of the second spouse, who dies with assets titled in his or her own name or to his or her trust, with assets valued at less than the exemption amount, there is no estate tax. This is achieved by utilizing 12 16

19 LIFE INSURANCE the surviving spouse s current credit exemption to eliminate the tax on the surviving spouse s estate. Practice Note Remember the gap between the Vermont estate tax exemption amount, $2.75 million, and the federal estate tax exemption amount, $5.34 million CHILDREN AS BENEFICIARIES Where the survivor of the couple is projected to have a taxable estate, the insured may want to make a transfer of the policy directly to the insured s children. Counsel will need to confirm with the insurance company what documents are needed to accomplish the transfer. Each of the life insurance companies has its own forms to transfer the ownership or change the beneficiary of a policy. Practice Note Pursuant to Vermont law, no power of attorney may give an agent, which would include a spouse or an adult child, the authority to exercise, by delegation, the fiduciary responsibility of a trustee, unless the instrument creating or amending the trust specifically authorizes the delegation. 14 V.S.A. 3504(b)(7). Further, No agent may make a gift or a loan to him or herself of property belonging to the principal unless the terms of the power of attorney explicitly provide for the authority to make gifts or loans to the agent. 14 V.S.A. 3504(f) IRREVOCABLE LIFE INSURANCE TRUST Another alternative for a couple with a projected taxable estate at the death of the survivor is to transfer a life insurance policy into an irrevocable life insurance trust. This must be accomplished more than three years before the death of the insured; otherwise, the death proceeds of the life insurance policy will be included in the calculation of the state and federal taxable estate of the decedent. I.R.C. 2035(b)(1). Where the insured creates an irrevocable life insurance trust and funds it, and the trustee, as the owner and applicant for the new policy, purchases a new policy on the life of the insured, the three-year rule will not apply

20 12.16 ESTATE PLANNING IN VERMONT Where the irrevocable life insurance trust agreement states that the policy proceeds are received by the insured s estate executor and are required to be used for the payment of state or federal estate taxes or other debts of the insured, those amounts will also be includible in the insured decedent s gross estate. The IRS interprets this as a deemed inclusion, meaning the amount is includible even if the trustee does not actually utilize the policy proceeds for such purposes. I.R.C. 2042(1); Treas. Reg (b)(1). Where using an irrevocable life insurance trust, if the purchase is orchestrated by a trustee of the irrevocable life insurance trust and all of the incidents of ownership of a policy on the life of the insured decedent are then acquired by the trustee of an irrevocable life insurance trust, then the life insurance policy proceeds are not included in the gross estate of the insured where the insured survives for less than three years. Since the insured decedent never acquires incidents of ownership in the life insurance policy on the insured s life, the three-year rule does not apply since the insured will not have made a transfer of a policy subject to inclusion in the insured s gross estate MINOR CHILDREN Similar to issues relating to real estate, minor children should not be named as the legal owners of life insurance policies based on their inability to engage in contracts due to their not being the age of majority, which is eighteen years of age in Vermont. Nor should minor children be named as the beneficiaries of a life insurance policy, since they cannot receive the policy proceeds while they are minors. An insured can utilize an irrevocable life insurance trust to meet multiple objectives, such as assuring immediate funds for the insured s surviving spouse, removing the policy proceeds from the gross estate of the insured, and providing additional funds for the benefit of minor children. To effectively utilize an irrevocable life insurance trust in order to remove the decedent s life insurance policy as an asset of the insured s state and federal gross estate, the following elements need to be satisfied: the policy must be assignable under state law; if the policy was transferred from the insured to an irrevocable trust, then the insured must live at least another three years beyond the formal date of the transfer; 12 18

21 LIFE INSURANCE alternatively, the policy must be initially purchased by the trustee of the irrevocable trust; the trust must be irrevocable; the trustee should not be the insured; and the trustee should not be legally obligated under the terms of the irrevocable life insurance trust to utilize the policy proceeds to pay estate taxes or other lawful debts of the insured PRESENT GIFTS Revenue Ruling provides the following guidance where the insured desires to make a transfer to an irrevocable trust and qualify it as a gift of a present interest for gift tax purposes: if the insured implements an irrevocable trust agreement; and the trustee acquires all of the incidents of ownership in a transferred policy; and the proceeds, as declared by the trust agreement, will be distributed to the named beneficiaries, outright, following the death of the insured; then the original transfer of the policy and the payment of subsequent premiums should qualify as a gift of a present interest for state and federal gift tax purposes. Revenue Ruling provides further guidance relating to a gift in trust for the benefit of a minor beneficiary where there is no guardian appointed. The rule is that if there is no impediment under the trust or local law to the appointment of a guardian, and the minor donee has a right to demand distribution, the transfer is a gift that qualifies for the annual exclusion allowed under Section 2503(b) of the Code. Revenue Ruling notes that the crucial thing in determining whether a gift is one of a future interest in property is postponement of enjoyment.... A gift in trust to a minor is not a future interest if the donee has a present right to the use, possession, or enjoyment, although such use, possession, or enjoyment may require the appointment of a legal guardian

22 12.19 ESTATE PLANNING IN VERMONT CRUMMEY PROVISIONS The IRS, in Revenue Ruling , has formally accepted the holding in Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), which declares the elements for qualifying gifts to a trust for the present interest exclusion. In order to qualify the transfer of a policy into an irrevocable trust and the payment of the subsequent payment of premiums for the annual gift tax exclusion ($14,000 in 2014), Crummey powers of withdrawal are granted in the body of the trust agreement to designated parties. The Crummey case held that so long as there was no legal impediment, either within the terms of the trust or under local law, to the appointment of a guardian to represent a minor beneficiary, then a withdrawal power could be granted to a minor over the additions made by an insured to the trust, which would allow the premiums paid to constitute gifts of a present interest. To implement Crummey provisions, classes of beneficiaries are declared in the trust. Each beneficiary is then given a withdrawal power, meaning a right to withdraw the gifts made to the trust, including each subsequent premium payment by the insured to the trustee. The amount that can be withdrawn is specified in the trust as a fixed amount or a formula. The trustee notices the beneficiaries of their right of withdrawal after receipt of an additional gift from the insured. The beneficiaries, which can include spouses, children, and the legal guardian of minor children (but should not be the insured as guardian of the minor children), then have a reasonable period of time to exercise their right of withdrawal or to leave the funds in place. The amount that is subject to withdrawal then constitutes a gift of a present interest qualifying for the annual exclusion. There are many Revenue Rulings, Technical Advisory Memoranda, Private Letter Rulings, and cases that address the Crummey notice, the reasonableness of the notice, who can sign on behalf of minors, and how to address more remote descendants as classes of beneficiaries. There are others relating to what happens when a fiduciary possesses fiduciary powers that could be exercised for his or her own benefit. See Priv. Ltr. Rul Practice Note Where counsel is serving as trustee of an irrevocable life insurance trust, counsel should include language in the trust or retainer agreement confirming that counsel has no investment responsibility over the policy while the insured is alive, and that the trustee s charge is to receive the premium notice, request funds from the insured, transmit the funds received to the insurance company, and pay out the policy proceeds once received upon the death of the insured pursuant to the trust agreement. Further, the trust or retainer 12 20

23 LIFE INSURANCE agreement should indicate that the trustee has no further responsibility to collect the premium from the insured other than to make a demand. If the trustee takes on further trust responsibilities, including investment and monitoring responsibilities, such as review of the ratings of policies and changes in policies owned by the trust, then the trustee may be subject to liabilities as an investor under the Uniform Prudent Investor Act. Pursuant to Vermont law, Fiduciary means a personal representative or a trustee. The term includes an executor, administrator, successor personal representative, special administrator, and a person performing substantially the same function. 14 V.S.A. 3322(3) INCIDENTS OF OWNERSHIP Life insurance policy proceeds are includible in a decedent s gross estate when received by the party named by the insured decedent, as well as when the insured retains powers over the life insurance policy during the insured s lifetime. Under I.R.C and 26 C.F.R , the gross estate of the insured decedent will include the proceeds of the life insurance policy in the following circumstances: where the proceeds are payable to the decedent s estate, 26 C.F.R (a)(1); where the proceeds are payable to other beneficiaries, 26 C.F.R (a)(1); where the terms of the insurance policy receivable by other beneficiaries indicate that the proceeds can be used to pay the debts, expenses, taxes, and lawful claims by creditors against the decedent or another beneficiary, regardless of whether the life insurance policy proceeds are received by an estate representative or trustee representative, 26 C.F.R (b)(1); where the insured of the insurance policy receivable by other beneficiaries retains the power to change the beneficiary, 26 C.F.R (c)(2); where the insured of the insurance policy receivable by other beneficiaries retains the power to control the payment terms to the named beneficiary, 26 C.F.R (c)(4); 12 21

24 12.20 ESTATE PLANNING IN VERMONT where the insured of the insurance policy receivable by other beneficiaries retains the power to surrender or cancel a life insurance policy, 26 C.F.R (c)(2); where the insured of the insurance policy receivable by other beneficiaries retains the power to change beneficiaries, 26 C.F.R (c)(2); where the insured s policy grants the insured the right to borrow against the insurance policy s accrued cash surrender value, 26 C.F.R (2); where the insured of the insurance policy receivable by other beneficiaries can then also utilize the policy proceeds as secured collateral for a loan, 26 C.F.R (c)(2); where the decedent, with or without another party, has the power to change the ownership of a policy or its beneficiaries, or the terms of payment, on a policy on the life of the insured or of another, held in trust, or not, in the insured s fiduciary capacity, 26 C.F.R (c)(4); where the decedent retains an interest in a policy on the life of another person, I.R.C. 2033; where the decedent retains an interest in a policy after transferring it, but retains an interest for the life of the insured or for any period not measured by the insured s death, whereby the insured still retains the right, alone or with others, to receive the policy or the income under the policy or to determine who shall receive the benefits of the policy or the income from the policy, I.R.C. 2036; 26 C.F.R (b)(3); when the decedent retains the right to remove and appoint trustees of a policy where the revocable or irrevocable trustees hold incidents of ownership over the policy on the life of the insured, I.R.C. 2036, 2042(2); 26 C.F.R (b)(3); when the decedent retains the power to assign the policy or revoke an assignment, 26 C.F.R (c)(2); or where the insured of the insurance policy receivable by other beneficiaries retains a reversionary interest in the policy or its proceeds, but only if the value of the reversionary interest immediately before 12 22

25 LIFE INSURANCE the death of the insured decedent exceeds 5 percent of the value of the policy, 26 C.F.R (c)(3). Practice Note Based on Revenue Ruling 95-58, which is included in Exhibit 12A, if a decedent insured retains the power to appoint a trustee and appoint an individual or corporate successor trustee that is not related or a subordinate of the insured decedent, as defined by I.R.C. 672(c), then this would not be deemed to be an incident of ownership causing inclusion of the policy in the decedent s gross estate GIFT TAX CONCERNS Where an irrevocable life insurance trust is used and the insured irrevocably transfers all incidents of ownership to the trustee and the insured retains no beneficial interest in or powers relating to the policy, the irrevocable transfer will be considered a completed transfer for state and federal gift tax purposes. Under Vermont law, a life insurance policy can be assigned. If the policy permits assignments, then the insured can make a completed gift for state and federal tax considerations. Practice Note Gift tax returns are required where the amount transferred, or the payment of subsequent premiums, exceeds the gift tax annual exclusion amount, currently set at $14,000 for VERMONT LONG-TERM CARE PLANNING AND MEDICAID PLANNING The Vermont Statutes address the concept of long-term care insurance with death benefits. The policy provider must produce an explanation of benefits, indicating the relationship between the long-term care benefit and the life insurance benefit. Section 8091 of 8 V.S.A. states as follows: (a) If an individual life insurance policy provides long-term care benefits within the policy or by rider, a policy summary shall be delivered at the time of policy delivery. In the case of direct response solicitations, 12 23