Advanced Underwriting Consultants

Ask the Experts – April 11

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client transferred his life insurance policy to an ILIT to avoid having the death benefit included in his gross estate. I’ve heard that if he dies within three years from the transfer, the death benefit will be brought back into his estate. Is this correct? Does the fact that he paid a gift tax based on the cash value affect the amount he would owe for estate tax purposes?

Answer: Yes, under Section 2035, the entire death benefit will be included in your client’s gross estate if he dies within three years from the date of the transfer to the ILIT. However, the fact that your client paid a gift tax (or used a portion of his unified credit to pay the tax) would lower the amount he owes for estate taxes.

For example, let’s say your client has given away enough money that he’s already used up his $5.34 million lifetime exclusion amount (as of 2014). Also suppose he owns a life insurance policy with a cash value of $600,000 and a death benefit of $1 million. If he transfers the policy to his ILIT in 2014, he will incur a $240,000 (40% of $600,000) gift tax in 2014. If he survives for three more years, the entire $1 million death benefit will be excluded from his gross estate.

On the other hand, let’s say he dies within three years from the transfer. Section 2035 brings the full value of the death benefit back into his gross estate, and ordinarily the $1 million death benefit would incur a $400,000 estate tax (40% of $1 million); however, your client would get credit for the $240,000 gift tax he has already paid, resulting in an estate tax of $160,000 ($400,000 less $240,000).

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.