| Assume that an older, wealthy widow(er)or | | | | present interest in property.Assume that the |
| divorced individual has a substantial amount in | | | | beneficiary does not exercise the right to |
| tax-deferred retirement plans such as defined | | | | withdraw the donation. The irrevocable life |
| contribution pension plans, 401k plans, 403b plans, | | | | insurance trust will use the donation by the parent |
| and traditional IRAs. The widow(er) wants to | | | | to pay the premiums on the life insurance.Where |
| leave the retirement plans to his or her | | | | does the parent obtain the money to donate the |
| children.The problem is that when the children | | | | money to the trust to pay the life insurance |
| inherit the tax-deferred retirement plans and take | | | | premiums? The parent converts the balances in |
| distributions from them, the distributions are fully | | | | the retirement plans into a life annuity. Therefore, |
| taxable to the children. The retirement plans are | | | | the parent receives payments for life and uses |
| income in respect of a decedent (known as IRD), | | | | part of them to pay the insurance premiums |
| which is taxable. In addition, the balances in the | | | | through the trust. At the parent's death, the |
| retirement plans are fully included in the | | | | annuity is worth zero. Therefore, the children do |
| decedent's gross estate for estate tax | | | | not have any income in respect of a decedent. |
| purposes.If the individual were married rather than | | | | Nothing from the annuity is included in the gross |
| being a widow(er)or a divorced individual, usually | | | | estate.The life insurance company pays the |
| the individual would want to leave the money in | | | | children the proceeds of the life insurance policy. |
| the retirement plans to his or her spouse. In that | | | | The proceeds of life insurance on account of the |
| case, the surviving spouse could transfer the | | | | death of the insured are not subject to income |
| money into his or her own IRA and treat the | | | | tax. They are not subject to estate tax because |
| account as his or her own. The surviving spouse | | | | the decedent did not own the policy.This plan |
| would avoid income tax on the money in the | | | | allows the parent to have an income stream |
| decedent's tax-deferred retirement plans. The | | | | during life from the annuity. The annuity |
| bequest would also qualify for the unlimited marital | | | | payments would be fully taxable unless the |
| deduction for estate tax purposes.Is there any | | | | individual has any basis in the annuity. The individual |
| way to achieve the parent's goal of having | | | | will need to use other income tax planning |
| enough money to pay living expenses and yet | | | | techniques to reduce the income tax resulting |
| leave a good inheritance to the children? The | | | | from the annuity payments.This strategy |
| answer is yes if the older, wealthy parent is | | | | converts amounts that would be subject to |
| insurable for life insurance purposes.Here is how | | | | income tax and estate tax to amounts that are |
| the solution would work. The parent obtains a life | | | | not subject to income tax or estate tax in the |
| insurance policy large enough to replace the | | | | hands of the children. This strategy requires the |
| balances in all the tax-deferred retirement plans. | | | | services of a tax advisor, an attorney, and a life |
| However, the parent is not the owner of the life | | | | insurance agent. They all must be competent and |
| insurance. The parent forms an irrevocable life | | | | exercise great care in implementing the strategy. |
| insurance trust that has a "Crummey Powers" | | | | However, if done correctly, this strategy can |
| clause, and the irrevocable life insurance trust | | | | result in substantial tax savings. It also gives the |
| owns the life insurance policy. This technique will | | | | parent more peace of mind knowing that the |
| keep the value of the life insurance out of the | | | | children will not have to pay taxes on the life |
| decedent's gross estate.A "Crummey Powers" | | | | insurance.Alan D. Campbell is a CPA in Arkansas |
| clause gets its name from a court case. It has to | | | | and Florida and is self-employed primarily as an |
| do with whether a gift is subject to gift tax. Gifts | | | | author of tax publications. He earned a Ph.D. in |
| that are less than the annual exclusion amount are | | | | accounting with an emphasis in taxation from the |
| exempt from gift tax as long as the gift is a | | | | University of North Texas. He is also admitted to |
| present interest in property. A "Crummey | | | | practice before the United States Tax Court. He |
| Powers" clause allows the beneficiary of a life | | | | has published numerous articles on tax topics in |
| insurance trust the right to withdraw gifts made | | | | professional journals. He is the co-author of the |
| to the trust that the donor intends to pay for life | | | | book Tax Strategies for the Self-Employed and |
| insurance premiums. As long as the beneficiary | | | | the revision editor of CCH Financial and Estate |
| has the right to withdraw the donation under the | | | | Planning Guide, 15th edition. |
| "Crummey Powers" clause, it is a gift of a | | | | |