June 4, 2015
Authored by: Stephanie Moll and Larry Brody
The trailers for the newest installment in the Mission: Impossible franchise, Mission: Impossible Rogue Nation, are being released and, as always when we see actors performing daredevil stunts, it makes us think about life insurance. Hazard (I use the term loosely, in light of what these guys do) of the job, I guess. So, once again, we thought we’d remind everyone about the use of life insurance trusts to reduce estate tax by re-posting the blog we wrote in after seeing his stunts for Ghost Protocol.
And, for your viewing pleasure, share another video of Mr. Cruise’s stunts. (I’m starting to think Tom Cruise or Mission: Impossible should start sponsoring our blog!)
It’s true, it is possible to transfer life insurance proceeds to your beneficiaries without having to pay estate tax on those proceeds. An insured can create an irrevocable trust that is designed to be the owner and beneficiary of a life insurance policy on the insured’s life. The only amount that the insured would end up paying transfer tax on (or allocating unified credit to) would be the amount the insured transfers to the insurance trust to pay the premiums on the policy. If the amount contributed to the trust does not exceed the annual exclusion amount allowable to each of the beneficiaries of the trust, and if the trust is designed to give the beneficiaries crummey withdrawal rights (the right to withdraw any such contributions to the trust over the period of 30-45 days after the transfer), the insured/grantor would not have to use any of his or her unified credit or pay any gift tax on these transfers, either.
In order for this strategy to work, (1) the insured must not retain any powers over the trust which would cause the trust assets to be included in his or her estate for estate tax purposes, (2) the policy cannot be payable to the insured’s estate, (3) the insured must have no “incidents of ownership” over the life insurance policy, and (4) the policy must not have been transferred to the trust within three years of the insured’s death.
1. The insured must not retain any powers over the trust which would cause the trust assets to be included in his or her estate for estate tax purposes.
In order for this first requirement to be met, the insured must not have the right, directly or indirectly, to the income of the trust for life, or any power, directly or indirectly, to affect the beneficial enjoyment of trust income or principal at the insured’s death (even as Trustee, which is why it is unwise for the insured to be a Trustee (or successor Trustee) of an irrevocable insurance trust).
2. The policy cannot be payable to the insured’s estate.
Even if the insured’s estate is not the named beneficiary of the life insurance policy, the policy will be deemed payable to the insured’s estate if the trust is able to pay debts or taxes of the insured’s estate.
3. The insured must have no “incidents of ownership” over the life insurance policy.
The term “incidents of ownership” is defined in an extremely broad manner, and includes any power of any kind over the economic benefits of the insurance policy. This includes: the power to change the beneficiary of the policy, the power to borrow against the policy, and the power to obtain the cash surrender value of the policy.
4. The policy must not have been transferred to the trust within three years of the insured’s death.
Section 2035 of the Code pulls back into the grantor’s estate any transfers made in the three years prior to his or her death. Therefore, if a policy is transferred to the trust within three years of the insured’s death, the policy, and therefore the proceeds, will be pulled back into the insured’s estate.
Given Tom Cruise’s earning potential, it is probably appropriate to guess that he has one or more very large insurance policies on his life. Hopefully, he has sought out sophisticated estate planning advice and has any such insurance policies in one or more irrevocable life insurance trusts for the benefit of his three children so that the proceeds of the policies will not be includible in his estate at his death.
Given the likely size of the policy (or policies), and the risks that he takes while performing his own stunts in movies such as the Mission: Impossible series, it’s also probably appropriate to guess that the premiums on any life insurance policies are fairly high.