In addition to minimizing estate taxes, effective and proactive estate planning accomplishes two often overlooked objectives. First, the plan should provide liquidity to the estate in order to pay estate taxes or debts and fully fund trusts, such as credit shelter and marital trusts. Second, proactive planning should effectively utilize the annual and lifetime gifting exclusions to transfer ownership of assets expected to appreciate significantly during the client's lifetime. The use of irrevocable life insurance trusts and Crummey trusts are important tools in accomplishing these objectives.
Irrevocable Life Insurance Trust
An insurance trust owns life insurance on an individual's life, removing the insurance proceeds from the insured's estate for estate tax purposes, saving potentially significant amounts of estate tax. For example, where spouses have a combined estate exceeding the federal and state estate tax exclusions, placing $1,000,000 of life insurance into an insurance trust may save $500,000 or more in estate taxes.
In order to provide liquidity to the estate, an insurance trust may purchase illiquid assets from the estate, such as real estate or closely held stock, so the estate may pay estate taxes, administration expenses or cash bequests to estate beneficiaries. Having liquid assets readily available prevents the estate from selling illiquid assets at a reduced price or on unfavorable terms. The terms of the insurance trust may provide for the establishment and funding of trusts similar to those established in the decedent's Will.
During the insured's lifetime, he or she may indirectly pay the insurance premiums through gifts to the trustee of the insurance trust. Provided the trustee complies with applicable notice requirements to trust beneficiaries (see Crummey Trust, below), gifts by the insured to the insurance trust will qualify for the annual exclusion from gift taxes
Crummey Trust
Despite its unfortunate name (the name of the party who successfully fought the IRS) the Crummey trust is an excellent device for estate planning. This irrevocable trust allows the donor to make gifts to the trust and qualify them for the annual exclusion from gift taxes. Upon receipt of a gift, the trustee must give the trust beneficiaries notice of the gift and the opportunity to withdraw from the trust and receive his or her share of the gift. Assuming the beneficiary does not exercise this withdrawal right, ownership of the gift will stay with the Crummey trust until the trustee distributes it, which may be at certain ages or upon a beneficiary's death.
Completed gifts made to a Crummey trust remove the gifted assets from the donor's estate for estate tax purposes, providing the opportunity to save significant estate taxes. A Crummey trust often works best in connection with an ongoing gifting plan where a donor desires to make gifts each year to children, grandchildren, etc. For example, the owner of a closely-held business may make annual gifts, up to the annual gifting exclusion, of company stock to Crummey trusts established for his or her children and grandchildren over several years. Both the value of the company stock when gifted and any future appreciation will escape estate taxation in the owner's estate.