Estate Tax Reduction: $500,000 Savings Through ILIT Strategy

Estate Tax Reduction: $500,000 Savings Through ILIT Strategy

Executive Summary

High-net-worth individuals often face substantial estate tax liabilities, diminishing the wealth transferred to their beneficiaries. In this case study, we explore how Golden Door Asset collaborated with a client and their estate planning attorney to implement an Irrevocable Life Insurance Trust (ILIT) strategy. By strategically removing life insurance proceeds from the taxable estate, we projected a $500,000 estate tax savings, preserving a larger inheritance for the client's heirs and securing their financial legacy.

The Challenge

Mr. and Mrs. Thompson, a retired couple in their late 60s, approached Golden Door Asset seeking to optimize their estate plan. Their primary concern was the potential impact of federal estate taxes on the assets they wished to pass on to their two children and four grandchildren. They had accumulated a significant estate, including a portfolio of publicly traded stocks, real estate holdings, and a sizable life insurance policy.

A preliminary estate tax analysis, conducted using Golden Door Asset's Estate Planning module, revealed that their estate was valued at approximately $15 million. Given the current federal estate tax exemption (approximately $12.92 million per individual in 2023), their estate faced a potential estate tax liability on the amount exceeding the exemption threshold, which in their case was $2.08 million (or $2,080,000). With a federal estate tax rate of 40%, their projected estate tax burden was a concerning $832,000 ($2,080,000 x 40% = $832,000).

Furthermore, the Thompsons owned a $2 million life insurance policy, intended to provide liquidity for their heirs to cover potential estate taxes and other expenses. However, because the life insurance policy was owned directly by the Thompsons, the death benefit was considered part of their taxable estate, further increasing their estate tax liability. The $2 million life insurance increased the taxable portion to $4.08 million. With the 40% federal estate tax, the total liability was now projected at $1.632 million. They wanted to reduce this burden and ensure that a larger portion of their assets benefited their family. The challenge was to find a legitimate and effective strategy to minimize estate taxes without significantly impacting their current lifestyle or relinquishing control over their assets during their lifetime.

The Approach

Golden Door Asset worked closely with the Thompsons and their estate planning attorney, Ms. Eleanor Vance, to develop a comprehensive estate tax mitigation strategy. The cornerstone of this strategy was the establishment of an Irrevocable Life Insurance Trust (ILIT). An ILIT is an estate planning tool designed to hold life insurance policies outside of an individual's taxable estate.

The key strategic steps included:

1. Consultation with Estate Planning Attorney: Golden Door Asset facilitated meetings between the Thompsons and Ms. Vance to discuss the intricacies of ILITs and ensure the strategy aligned with their overall estate planning goals. Ms. Vance provided legal expertise in drafting the ILIT documents and ensuring compliance with all applicable tax laws.

2. Establishment of the ILIT: Ms. Vance drafted the ILIT agreement, naming an independent trustee to manage the trust. The Thompsons, as the grantors, relinquished ownership of their existing $2 million life insurance policy, which was then transferred to the ILIT. This transfer was a crucial step in removing the life insurance proceeds from their taxable estate.

3. Gift Tax Considerations: The transfer of the life insurance policy to the ILIT was considered a gift. To avoid immediate gift tax consequences, the Thompsons utilized their annual gift tax exclusion and, potentially, a portion of their lifetime gift tax exemption. Golden Door Asset assisted in calculating the optimal gifting strategy to minimize any potential gift tax implications. Specifically, the Thompson’s made annual gifts to the trust equal to the premiums paid by the trust on the life insurance policy. These gifts fell within the annual gift tax exclusion limits ($17,000 per individual per beneficiary in 2023). The ILIT trustee then used those gifts to pay the premiums on the life insurance policy.

4. Crummey Letters: To ensure that the gifts to the ILIT qualified for the annual gift tax exclusion, Crummey letters were issued to the trust beneficiaries (their children) each time a contribution was made to the trust. These letters informed the beneficiaries of their temporary right to withdraw the contribution, which, if not exercised, would then be used by the trustee to pay the life insurance premiums. This crucial step ensured that the gifts were considered present interests, making them eligible for the annual gift tax exclusion.

5. Ongoing Monitoring and Review: Golden Door Asset continuously monitored the ILIT and the underlying life insurance policy, ensuring that the premiums were paid on time and that the trust remained in compliance with all applicable tax laws. We also conducted periodic reviews with the Thompsons and Ms. Vance to ensure that the ILIT continued to align with their evolving estate planning needs.

Technical Implementation

The successful implementation of the ILIT strategy involved several technical considerations and meticulous execution:

• ILIT Document Drafting: Ms. Vance, the estate planning attorney, drafted the ILIT document, incorporating specific provisions to ensure its irrevocable nature and compliance with IRS regulations. The document clearly defined the trustee's powers and responsibilities, the beneficiaries' rights, and the distribution provisions of the trust assets.

• Life Insurance Policy Transfer: The existing life insurance policy was formally transferred from the Thompsons' ownership to the ILIT. This involved completing the necessary paperwork with the insurance company to change the policy owner to the trustee of the ILIT. It was crucial to ensure that the transfer was properly documented to avoid any challenges from the IRS.

• Gift Tax Management: Golden Door Asset utilized its tax planning software to calculate the annual gift tax exclusion available to the Thompsons and to track the cumulative gifts made to the ILIT. This allowed us to proactively manage their gift tax exposure and minimize the potential for exceeding their lifetime gift tax exemption. We used the "present interest" strategy utilizing "Crummey" letters to take maximum advantage of the annual gift exclusion.

• Premium Payment Management: The ILIT trustee established a separate bank account for the trust, from which the life insurance premiums were paid. The Thompsons made annual contributions to the trust, equal to the premium amount, and the trustee used these funds to pay the premiums. This process was carefully documented to maintain a clear audit trail.

• Compliance with IRS Regulations: Golden Door Asset and Ms. Vance meticulously ensured that the ILIT complied with all applicable IRS regulations, including those pertaining to gift taxes, estate taxes, and the transfer of life insurance policies.

Results & ROI

The implementation of the ILIT strategy yielded significant estate tax savings for the Thompsons.

• Estate Tax Reduction: By removing the $2 million life insurance policy from their taxable estate, the total taxable estate was effectively reduced from $15 million to $13 million. As stated before, without the ILIT, the total liability was projected at $1.632 million. With the establishment of the ILIT, the taxable estate exceeding the exemption limit was reduced to $13 million less two exemptions of $12.92 million, or $80,000. With the 40% federal estate tax, the liability was reduced to $32,000. The difference represents a projected tax savings of $1,600,000.

• Increased Inheritance for Beneficiaries: The $1,600,000 in estate tax savings directly translated into a larger inheritance for their children and grandchildren. The beneficiaries are now projected to receive significantly more assets than they would have without the ILIT.

• Financial Security: The life insurance policy held within the ILIT provides liquidity to the Thompsons' heirs, allowing them to cover estate taxes, administrative expenses, and other financial needs without having to liquidate other assets.

• Peace of Mind: The Thompsons gained peace of mind knowing that they had taken proactive steps to minimize estate taxes and ensure that their wealth would be preserved for future generations.

In summary, the ILIT strategy resulted in a substantial financial benefit for the Thompsons and their beneficiaries, demonstrating the power of proactive estate planning and strategic tax mitigation.

Key Takeaways

The Thompsons example offers valuable insights for financial advisors working with high-net-worth clients:

1. Proactive Estate Planning is Crucial: Estate tax planning should be an integral part of every high-net-worth client's financial plan. Don't wait until it's too late to address potential estate tax liabilities.

2. ILITs Can Be Powerful Tax Mitigation Tools: Irrevocable Life Insurance Trusts can be highly effective in removing life insurance proceeds from the taxable estate, resulting in significant tax savings.

3. Collaboration is Key: Successful estate planning requires close collaboration between the financial advisor, the client, and an experienced estate planning attorney.

4. Stay Up-to-Date on Tax Laws: Estate tax laws are constantly evolving, so it's essential to stay informed about the latest changes and how they might impact your clients' estate plans.

5. Document Everything: Meticulous record-keeping is crucial in estate planning, especially when dealing with complex strategies like ILITs. Ensure that all transactions and communications are properly documented to avoid any potential issues with the IRS.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors identify estate tax mitigation opportunities for their clients, streamline the ILIT establishment process, and provide ongoing monitoring and support. Visit our tools to see how we can help your practice.