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Estate Planning Simplicity With Survivor Standby Trusts

Life insurance can be a valuable asset to provide estate tax liquidity and help effectuate wealth transfer goals. When insurance is owned by an irrevocable life insurance trust (ILIT), benefits may include increased creditor protection, transfer tax advantages, and the enhanced ability to direct how and when distributions are made to trust beneficiaries. But when it comes to wealth transfer planning today, many financial professionals echo a similar concern — the need to build flexibility and control into their clients’ plans.

High federal exemptions ($24,12M for a married couple in 2022) paired with competing financial priorities and general uncertainty in the planning environment can make it difficult. While there are ways to build greater access and control into trust drafting, such as spousal access language, some clients still prefer personal ownership.

What if you could offer a strategy that provides flexibility today while mitigating estate tax concerns tomorrow? For married couples, the use of a survivor standby trust may be an excellent option. With this technique, the life insurance is initially personally owned and later becomes trust-owned.

Here’s how it works

1. The spouse with the anticipated shorter life expectancy purchases a survivorship life insurance policy. The policy is personally owned by that spouse and he pays the premiums out of personal funds.

2. Working with his estate planning attorney, the client creates a credit shelter trust. The trust can be funded during the client’s life or at death via the terms of his will or revocable trust.

3. The owner-spouse names the credit shelter trust as the contingent owner and beneficiary of the policy (i.e., the credit shelter trust “stands by” as the owner/beneficiary after the owner-spouse’s death).

4. During his life, because the policy is personally owned, the owner-spouse maintains full control over the policy, including the ability to fully access potential policy cash value for supplemental income needs.1

5. If the owner spouse dies first (as anticipated), the credit shelter trust becomes the policy owner. (Note: the fair market value (FMV) of the policy will be included in the owner’s estate.)

6. At the surviving spouse’s death, the death benefits are paid to the credit shelter trust estate tax-free.

7. The trustee distributes the death benefit and any other trust assets according to the trust terms.

Benefits

• Flexibility and control — The owner-spouse has unencumbered access to policy cash values and the plan can be changed to meet changing planning goals during the client’s life.

• Gifting — No gifting or trust is required today because premiums are paid out of personal funds.

• Limited estate tax exposure — If the owner-spouse dies first, only the FMV of the policy is included in his estate.

• Cost effective death benefit protection —

The survivorship policy can offer enhanced legacy protection and liquidity for estate planning needs a cost effective price.

• Spousal access language — The surviving spouse can be a beneficiary of the credit shelter trust (Note: there are several considerations that should be discussed with counsel to ensure the death benefit is not includable in the survivor’s estate.)

Considerations

• After the owner-spouse’s death, the surviving spouse loses direct access to the trust assets (indirect access may still be possible via spousal access language).

• The trustee may have to pay additional premiums on the policy at the first spouse’s death.

• If the non-owner-spouse dies first (i.e., out-of-order death), the full death benefit will be subject to estate taxes at the owner-spouse’s death. To rectify this, the owner spouse can gift the policy at the first death to the trust (note, transfers within three years of death will be included in his estate).

• This technique may also work with a single-life policy (the spouse most likely to die first is the owner/ beneficiary of a policy on the other spouse’s life).

• The credit shelter trust must be drafted by experienced counsel taking applicable state law into consideration.

Conclusion
Building flexibility into plans is often the driving force to get our clients to engage in planning. This type of technique offers married couples many options to address evolving needs. For example, if their financial circumstances change, they have access to the potential policy cash values for personal use. Alternatively, if they do not need the policy for personal needs and/or their estate tax exposure increases, the owner-spouse has the option to gift the policy to the trust for its FMV at any time. Or, if the owner-spouse dies first, the policy will be transferred to the credit shelter trust and the death benefit will ultimately be received by the trust estate tax-free, which may enhance the total amount left to heirs.

Please note, this article is not intended as advice and anyone interested in this topic should speak with their independent professionals.

Carol brooks

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