Rich Behrendt, director of estate planning at Bairds private wealth management group, recently received a call from one of his firms financial advisors.
One of this advisors clients has an old irrevocable life insurance trust, Behrendt said. After passage of the new tax law, the client no longer needs the ILIT, and hes not happy paying thousands of dollars a year to the corporate trustee. Behrendt says that he expects to get many more calls from advisors on this subject, as well as calls about existing qualified personal residence trusts (QPRTs) and family limited partnerships (FLPs).
Irrevocable life insurance trusts were crated to address concerns about paying federal estate tax. However, the tax law passed in early 2013 permanently increased the federal estate tax exemption to $5.25 million in 2013, indexed to inflation in future years. Exemption portability between spouses also was made permanent, so its relatively easy for a married couple to leave up to $10.5 million to their heirs, without owing this tax. (States may tax estates, but at relatively low rates.) Only a tiny fraction of the population will have to plan for federal estate tax, Behrendt said.
What can be done in such situations? These trusts are irrevocable, Behrendt said, so changing them might not be easy. Ill be looking into state law, and into the clients individual circumstances, to see if a modification is possible. Going before a court might be required.
Some clients with ILITs, Behrendt said, may want to cancel the life insurance policy and terminate the trust. In some cases, though, keeping the ILIT in place could make sense. Income taxes have become more of a concern because of the higher top rate, the Medicare surtax, and various phaseouts for high-income taxpayers. Thus, an IRA beneficiary might welcome access to life insurance proceeds flowing from an ILIT to help cover the effective tax on IRA distributions.
Even more than that, Behrendt said, clients might want to keep the life insurance in place as a guaranteed legacy. Theyll know that no matter how much they spend, for medical care or long-term care or just the cost of living for many years, their beneficiaries will receive life insurance benefits. Typically, proceeds from a policy held in an ILIT escape both income and estate tax.
The situation with a QPRT might be different. These trusts allow a primary residence or another home to pass to heirs without estate tax inclusion. For many clients, the $5.25 million or $10.5 million federal estate tax exemption has banished this concern.
Typically, Behrendt, a QPRT calls for the clientthe original home ownerto move out of the home after the trust term or else to start paying a fair rent to the new owner, who might a son or a daughter. If thats the case, the client might choose to stay in the house or keep using the vacation home without paying rent. If that unwinds the trust, the heirs might benefit from a basis adjustment. That is, the heirs eventually may be able to inherit the house with a step-up in basis to current value and avoid paying income tax on a future sale.
As for FLPs, even if the estate tax shelter is no longer needed, these vehicles might provide valuable asset protection, Behrendt said. The bottom line is that advisors should contact clients who formerly were concerned about federal estate tax but no longer expect that tax to be an issue. Find out if such estate tax planning vehicles had been created and start the conversation about what, if anything, needs to be done now.