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