Estate Planning

• Create an estate that will support dependents: The most essential function of life insurance is to assure the necessary support for dependents in the event of a breadwinner’s premature death.
• Preserve assets that would otherwise have to be sold to pay any estate taxes: Whether or not your assets are illiquid, if your estate is subject to estate taxes, a large percentage of your assets may have to be sold within nine months of your (or a surviving spouse’s) death to pay estate taxes. Life insurance provides cash that may be needed to pay estate taxes.
• Equalize or balance the value of your children’s individual inheritances: If only some of your children will inherit certain assets – for example, a family business or a home (including a second residence) – life insurance for the benefit of other family members can be used to equalize the distribution of your estate.
• Fund a buy-sell agreement or business succession plan: Business buy- sell agreements or succession plans create rights and obligations to transfer or purchase business ownership interests under certain circumstances, including the death of an owner. Life insurance can be used to fund this obligation.

Life insurance can be divided into two main categories: term and permanent. Term Insurance. Term insurance is generally the least expensive (in the short term) and the least complicated type of life insurance. Coverage is typically provided for a specific term (period of time) – for example, for 1, 5, 10, 15, 20 years or even longer. The premium may be level for the full term period or may increase over time. Coverage will cease if the insured is still alive at the end of the term. Many term policies include a “conversion option,” which guarantees the policy owner the right to convert the policy to permanent coverage without having to re-qualify. However, conversion options vary among carriers and products as to both the latest date for conversion and the choice of products available for conversion. Permanent Insurance. Assuming that an individual has a permanent need for life insurance, permanent insurance may be appropriate. There are many different types of permanent insurance, and variations within each type. If permanent insurance is needed, it is advisable to speak to a knowledgeable agent about the most appropriate type for your needs. In addition, life insurance may insure just one life or may be “joint and survivor” insurance, which pays at the death of the survivor of two individuals (generally husband and wife).

The federal estate tax is a tax imposed on the transmission of property at the death of an individual (the “decedent”). For 2012 the top estate tax rate is 35%; in 2013 it is scheduled to increase to 55%. In 2012 the first $5,120,000 (subject to certain adjustments) (the “exemption”) passes free of tax; the exemption is scheduled to reduce to $1,000,000 in 2013. The tax is due nine months after death. Generally, the tax is imposed on all property that passes as part of the decedent’s probate estate, property in any trust the decedent could amend or revoke at his/her death, property held in joint tenancy (except only one-half if held jointly with a spouse), property over which the decedent could designate a beneficiary (e.g., a POD bank account, life insurance on the decedent’s life, retirement plan benefits, IRAs), property over which the decedent has a general power of appointment, property transferred by the decedent over which the decedent maintained an interest or the power to designate who can benefit from the property, and marital trusts established by a predeceased spouse. In determining the tax, the decedent’s executor can deduct debts, expenses of administration, amounts passing to charity, amounts passing to a spouse (there are special rules if the spouse is not a U.S. citizen) and taxes paid to any state.

Some, but not all, states impose death taxes. Many states, including Illinois, impose a tax based on the credit that used to be allowed for estate taxes paid to a state on the federal estate tax return (this tax is often referred to as a state estate tax). Many of the states that impose such tax provide for a smaller exemption than the federal exemption. Some states impose a death tax based on the relationship of the person inheriting to the decedent and the amount inherited by such person (this tax is often referred to as an inheritance tax). Those closest to the decedent (e.g., a spouse or children or other descendants) are assessed at lower rates and with larger exemption than others (e.g., siblings or their descendants, more distant relations or persons with no blood relationship). A few states impose a tax based on the size of the estate without regard to the old federal credit for state death taxes.

The federal gift tax is tax on the gratuitous transfer of wealth. The gift tax is imposed each calendar year on the fair market value of property transferred by any individual to a donee other than a political organization. The tax applies to direct and indirect transfers of real and personal property, both tangible and intangible. The fair market value of the transfer is determined as of the date of the gift. Certain gifts to spouses qualify for a marital deduction from gift tax. Certain gifts to charity qualify for a charitable deduction from gift tax. The amount of gifts remaining after applying any marital and charitable deductions, and after applying the annual exclusions discussed in the following FAQ, are “taxable gifts.” Each individual has a lifetime exclusion that is applied against lifetime taxable gifts. For 2011 the lifetime exclusion is $5,000,000 and for 2012 the lifetime exclusion will be $5,120,000, but under current law the lifetime exclusion will return to $1,000,000 in 2013. After an individual’s lifetime exclusion has been exhausted by aggregate lifetime taxable gifts, gift tax is imposed. For 2011 and 2012, the gift tax rate is 35%. Under current law, in 2013 the gift tax will be imposed at graduated rates up to 55%. The donor is responsible for filing a federal gift tax return and paying any federal gift tax. The return must be filed and the gift tax paid by April 15 of the year following the year when the gift was made.

Each individual may make annual exclusion gifts of up to $13,000 (for 2011 and 2012) per individual each year. (The original annual exclusion amount of $10,000 is adjusted for inflation since 1999, but only in $1,000 increments.) Annual exclusion gifts are free from gift taxes and do not reduce an individual’s lifetime exclusion. To qualify for the annual exclusion, a gift must confer a “present interest” to the recipient. Outright gifts, gifts to custodian accounts under the Uniform Transfer to Minors Act and gifts to 529 college savings accounts qualify for the annual exclusion.  Gifts to trusts generally are not present interest gifts, but there are limited exceptions. Generally, there is no gift tax return requirement if the only gifts you make during the year are annual exclusion gifts. A wife and husband may make a special election to be treated as if each of them had made one-half of all of their gifts during the year. This election permits a married couple to use their annual exclusions to collectively give $26,000 per individual without regard to who actually made the gift. For example, if during a calendar year Wife gives $26,000 to Daughter, and Husband makes no gifts to Daughter, $13,000 of Wife’s gift would qualify for the annual exclusion and $13,000 would be treated as a taxable gift. However, if Husband makes the split-gift election, the entire $26,000 gift would qualify for the annual exclusion. A gift tax return must be filed to make a split-gift election.