An Introduction to
Concepts and Strategies
NOT A DEPOSIT OF OR GUARANTEED BY ANY BANK OR ANY BANK AFFILIATE MAY LOSE
VALUE NOT INSURED BY FDIC OR ANY FEDERAL GOVERNMENT AGENCY
This cliché holds true for many things, including your finances. Without proper planning, your goals may remain in sight but out of reach. Your financial strategy should have a beginning, middle and an end. Set your goals, work toward them, and make sure your dreams are fulfilled.
It is important that you don’t confuse the components of a solid financial strategy with the strategy itself. Do you want to work your whole life, invest wisely and build a legacy only to find that your wealth is just an illusion to your beneficiaries, a mirage that fades away when you die? No matter what stage you are living in your financial life, it is never too early to learn about and consider the effects of your strategy’s final component – wealth transfer. You need to think about your will, trusts, competency issues and transfer-tax consequences.
Despite media hype that the estate tax is dead, the facts of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) say otherwise. Under the current law, the estate tax is only repealed in 2010. It exists before then and, barring an additional act of Congress, will be reinstated in 2011. In addition, tax law could also change at any time in between, as congressional and presidential elections alter the political landscape.
Depending on when you die, and the size of your estate, estate taxes could consume a large portion of your legacy. Can you afford not to plan today for the uncertainty of tomorrow?
As you can see in the chart to the left, the estate tax rate is 45% in 2008 through 2009. In 2010, the estate tax is repealed. Then, on January 1, 2011, the rules prior to EGTRRA are re-instated and the top marginal rate returns to 55%.
Failing to Plan is Planning to Fail
Gradual Decrease in the Highest
Federal Estate Tax Rates 2008-2010
What is Estate Planning?
The objective of estate planning is to conserve and transfer your assets through a logical process that seeks to decrease legal entanglements and taxes while increasing the amount of wealth transferred to your beneficiaries. Estate planning can include, but may not be limited to, any or all of the following: your will, trusts, powers of attorney, living will and life insurance or other funding source.
A common misconception about estate planning is that it is only for the wealthy. While the wealthy may require more involved estate planning, the process is beneficial to everyone who has assets that will need to be transferred upon death. Depending on your age, family status and assets, the process could be no more involved than establishing a will, or as complex as establishing and funding trusts, and setting in place a variety of tax-reducing strategies.
If you are a small business owner, estate planning for your business is also an important process. Should business ownership be transferred to beneficiaries or new owners – perhaps current, key employees? Is there a current business continuation agreement in place? Is it funded? If so, how? Will the business assets be liquidated and distributed? If so, how? How would selling the business while you are alive impact your estate?
Basic Estate Planning
Without a will, intestacy laws will determine the distribution of your assets, and such distribution may not be what you would have wanted. Even with a will, your estate will go through probate court; however, the court will generally abide by the terms set forth in your will.
If you are a single person with assets of less than $1 million dollars, consider establishing a simple will that distributes your assets as you choose, after debt obligations are satisfied.
If you are married, many spouses write wills that leave all assets to each other and establish contingency plans if both husband and wife die simultaneously. Due to the unlimited marital deduction, a surviving spouse can inherit the entire estate without tax liability (depending on the date of death). The surviving spouse must be a U.S. citizen to qualify for this deduction. If the surviving spouse is not a U.S. citizen, a special trust known as a Qualified Domestic Trust can be used. However, if more than $1 million is bequeathed out of either spouse’s estate, the estate could be exposed to an estate tax liability. As with all matters of a tax or legal nature, be sure to consult with your own tax or legal counsel for advice.
If you have any children, there are additional considerations. Your will should make clear your wishes for custody of any minors in the event of a single parent’s death or the simultaneous death of both parents. In addition, you will need to determine what a child will receive through a potential inheritance and when. There are other personal considerations you may make when establishing your will, including a living will and naming a power of attorney for healthcare and financial decisions. A living will allows you to make decisions regarding prolonging your life through various means prior to a time when you may not be capable of making those decisions, relieving your family of that burden. Naming a healthcare power of attorney or healthcare proxy places medical decisions in trusted hands. A durable power of attorney is a written document executed by an individual (the ”principal”) authorizing another person (the “attorney in fact”) to act on his/her behalf. A power of attorney authorizes another individual to enter into and discharge virtually all legal obligations on behalf of the principal.
All wills require an executor. Often people name a family member as executor since such a person is familiar with the family’s situation and may be more sensitive to its needs. However, naming a corporate executor may have advantages as well, including expert knowledge and objectivity. Many banks offer this service through their trust departments. You may also name co-executors.
Many events can result in the need for updating an existing will. It is generally a good idea to regularly review your will with an attorney to determine whether any changes are needed. Some events that could trigger the need to revise your will include:
• Moving to a new state
• Death of a spouse or any stated beneficiary • Divorce from spouse
• Birth or adoption of any children • Change in the value of assets
• Change in asset structure, such as shifting from stocks to real estate
Advanced Estate Planning
Generally, more advanced estate planning is necessary if your assets total more than $1 million, or whatever the current applicable exclusion amount may be in any given year. However, $1 million is a good baseline since it is scheduled to be the applicable exclusion amount in 2011 when the estate tax reverts to prior law. In the meantime, under the Economic Growth and Tax Relief Reconciliation Act of 2001, the amount varies.
The chart to the right shows how the estate tax exemption will increase, with the tax “repeal” effective in 2010. The exemption amount increases to $2 million per person in 2008 and then $3.5 million per person in 2009. Full repeal of the estate tax occurs on January 1, 2010.
Because budget rules prevent Congress from approving tax cuts 10 years prior to their enactment, it must either re-instate the tax repeal by December 31, 2010 or the tax will revert to the law that was in effect in 2001. Congress will be required to reconsider the issue in the intervening years.
Be aware that many people underestimate the size of their estates. Your estate includes all of
your assets – both liquid and illiquid. This includes your investment portfolio, bank accounts, real estate, business interests, automobiles, jewelry and even collectibles. A proper estate review with a qualified financial professional can help ensure that any tax liability is not greater than you may perceive.
Applicable Exclusion Amounts Under
Depending on when you die, estate taxes could still consume up to 55% of your estate. Estate planning now can save a lot of headaches later. For instance, without proper planning, your beneficiaries may be forced to liquidate assets, potentially at a loss. If there is an estate tax liability, it usually must be paid to the federal government within
nine months of death and sometimes sooner to various state taxing authorities.
Some potential means of funding the estate tax bill include:
• Cash on hand: Some estates may have enough cash available to cover estate expenses.
• Liquidating Assets: This could include such things as the sale of securities, real estate, collectibles or business assets.
• Borrowing: A loan may be secured to cover the expenses, buying time at the cost of interest.
• Life Insurance: This option uses a portion of the estate now to pay life insurance premiums in order to use the death benefit to cover estate expenses.
In determining and seeing through your best options, you may benefit from consulting a variety of professionals. Your estate planning team could consist of any or all of the following persons: estate planning attorney, accountant and financial professional. Sometimes certain professionals can fulfill more than one role. The more involved the plan, the more help you will need.
Estate planning may involve strategies to effectively plan for and cover estate taxes and other expenses, strategies to reduce the size of your taxable estate, or, more likely, a combination of both.
For example, one strategy may involve taking an Individual Retirement Account (IRA) you do not need for more than minimal income distributions and structuring it to remain intact longer. By doing so, you may extend the accumulation period and defer taxes for the benefit of children and grandchildren. Effectively “stretching” an IRA can be achieved through certain ownership and beneficiary structures. Your financial professional can help you explore this concept if you have an IRA and will not be using it for more than minimum distributions during your retirement.
Trusts can help you meet a variety of your wealth transfer goals and avoid some pitfalls that can occur without proper planning. The following are the basics of some common trusts and the estate planning issues they can help address.
When dealing with a sizeable estate, a simple all-to-spouse transfer does not make use of one spouse’s applicable exclusion amount. Upon the first death, the surviving spouse inherits the entire estate tax-free due to the unlimited marital deduction. Since the applicable exclusion amount is available on an individual basis, the first spouse to die essentially forfeits the advantages of the applicable exclusion amount. Then, when the surviving spouse dies, only the applicable exclusion amount of the surviving spouse will be considered, leaving a larger than necessary estate to be taxed. The surviving spouse must be a U.S. citizen to qualify for the unlimited marital deduction. If the surviving spouse is not a U.S. citizen, a special trust known as a Qualified Domestic Trust must be used.
A properly structured trust strategy can provide an effective means of using both spouses’ applicable exclusion amounts. This is known as an A-B Trust or a Marital/Credit Shelter Trust arrangement. Here’s how it works.
A-B Trust or Marital/Credit Shelter Trust
An “A” trust, also known as a Marital Trust, is often established in conjunction with a “B” trust. An “A” trust qualifies for the unlimited marital deduction. The surviving spouse must receive income from the trust and may even receive all or a portion of the principal of the trust at the trustee’s discretion. However, the trust will be included in the surviving spouse’s estate.
Couples who utilize an all-to-spouse will and have children may face an extra challenge if the surviving spouse should remarry. Imagine that a surviving wife, for instance, brings her deceased husband’s assets to a new marriage. What if that couple then establishes a simple spousal will and the wife predeceases her new husband
?The first husband’s assets are transferred to her new husband, diluting or even eliminating any inheritance to children from the first marriage. The issue can become even more complicated if the second marriage produces children as well.
The QTIP (Qualified Terminable Interest Property) trust is one approach to avoiding this potentially complex situation. Through a QTIP trust, a person can provide for a surviving spouse through that spouse’s lifetime
and define the ultimate beneficiaries of the assets upon the death of the surviving spouse. Thus, a couple can
take comfort in knowing that they have provided for a surviving spouse while protecting the ultimate interests of the children, regardless of future relationships.
“B” Trust Funded with Applicable Exclusion Amount
of First Spouse to Die – No Estate Tax Due
• Income and/or Principal to Spouse and/or Non-Spouse Beneficiaries
OPTION 2: Trustee may be able to increase the amount ultimately
transferred to the non-spouse beneficiaries by using all or a portion of trust assets to purchase life insurance on the
surviving spouse. The policy death benefit may be received
income and estate tax-free.
If you are not going to use “B” Trust assets. For benefit of spouse.
If properly drafted, qualifies for unlimited marital deduction. Not taxed until death of sur viving spouse.
Revocable Living Trust
A Revocable Living Trust is a legal document similar to a will. It con-tains instructions for the management of an individual’s assets during the individual’s life and in the event of disability. It also contains instructions for the disposition of the individual’s assets after death.
You should consult with your attorney for the tax implications of naming yourself versus someone else as trustee of your living trust, as well as for any implications of transferring the titles of your assets to the trust.
If properly planned, a living trust can reduce or eliminate the time and possible expense of probate, and retain privacy for the family. The probate process is public, while transfers through a living trust can remain private. Only assets titled to the trust avoid probate. Consult your estate planning team to find out what will work best for your situation.
Irrevocable Life Insurance Trust (ILIT)
If you are planning to use life insurance as means of funding your estate settlement costs, an Irrevocable Life Insurance Trust can remove the death benefit proceeds from your estate for federal estate tax purposes. More on the structure and benefits of an irrevocable life insurance trust can be found in the life insurance section of this brochure.
Naming a Trustee
Responsibilities of a trustee could include: • Implementing the trust’s terms
• Distributing and/or reinvesting any returns
• Providing accounting services for the trust, including: – Tracking principal and income
– Filing tax returns – Tracking cost bases
• Arranging payment of any of the trust’s debt obligations
There may be federal gift tax consequences associated with the funding of an Irrevocable Life Insurance Trust.
Lifetime gifting is another strategy for helping to reduce the size of your taxable estate. In addition, gifts given to charitable organizations are removed from your taxable estate on transfer. As a result, many people will name favorite charitable organizations as beneficiaries to certain assets.
Charitable giving can also benefit your tax planning and asset management while you are alive. A gifting strategy, like other aspects of your estate plan, should be carefully thought through with your tax and legal professional to make sure that it works toward your goals and avoids potentially negative implications.
The Role of Life Insurance
When you die, the death benefit is paid to beneficiaries income tax-free. The proceeds can then be used to pay your estate tax bill and other expenses. When compared to other funding options, such as borrowing or liqui-dating high-yielding assets, life insurance can be an extremely cost-effective means of funding estate expenses.
However, like all components of your estate plan, there are special considerations for your life insurance choice. If you are the owner of the policy, the death benefit may be included in your estate for federal estate tax pur-poses. As a result, many life insurance purchases for estate planning are made through an Irrevocable Life Insurance Trust, or ILIT. The ILIT is the owner and the beneficiary of the life insurance policy. You make gifts to the ILIT to cover the premium costs. (Don’t forget gift tax considerations in your planning.) The ILIT then purchases the insurance. Since a properly drafted ILIT is not part of your federal taxable estate, the death ben-efit proceeds are received by the ILIT income and estate tax-free. There may be federal gift tax consequences associated with the funding of an Irrevocable Life Insurance Trust. In addition, the gifts made to the trust to cover premium payments are reducing the value of your taxable estate, and any accumulation of the life insur-ance account value occursoutside the estate, as well.
A Survivorship Access Trust (SAT) is a irrevocable life insurance trust that is drafted in such a manner so that one of the assets owned by the trust is a survivorship life insurance policy, through which one insured can enjoy access to the policy’s cash value during his or her lifetime, without causing the inclusion of the death benefit in the estate of either insured. Through a properly-drafted SAT, the trustee can be authorized to make distributions of both income and principal of the trust to the one insured who is the beneficiary of the SAT. At the death of the second insured, death benefit proceeds are received by the SAT income and estate tax-free.
Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policy’s Account Value and Death Benefit. Assuming a pol-icy is not a Modified Endowment Contract (MEC), loans are free from current Federal taxation and withdrawals are taxed only to the extent that they exceed the policyowner’s basis in the policy. Distributions from MECs are subject to Federal income tax to the extent of the gain in the policy and taxable distributions are subject to a 10% additional tax, with certain exceptions.
A Single Life Access Trust is a life insurance ownership arrangement through which a non-insured spouse can enjoy access to a single life policy insuring his/her spouse, without causing inclusion of the death benefit in the estate of either spouse. If the non-guarantor spouse dies first, the surviving spouse will have no direct access to cash values.
Plan Your Plan
It is important to ensure that your goals and strategies are properly aligned in order to make your estate plan effective. For example, using the IRA example previously mentioned, if your goal is to use the IRA as an asset to live off during retire-ment, using a stretch-IRA strategy would not make sense. It would likely even be counterproductive.
To create an effective estate plan, you must first work with your tax and legal advisor or professional to organize your affairs and be sure your plan will cover all the bases before you implement it. This “planning the plan” will help you ensure that your goals and strategies are properly aligned. A high-level “to do” list for estate planning should include:
✓ Identification of assets and assembly of all related paperwork: titles, recent statements and tax filings, etc. ✓ Assembly of any necessary professional assistance ✓ Last Will and Testament
✓ Living Will
✓ Healthcare Power of Attorney ✓ Durable Power of Attorney
✓ Identification and review of potential trust strategies ✓ Identification of estate value and asset-types
✓ Identification of retirement needs
✓ Identification of estate tax liability and funding source ✓ Analysis of estate transfer goals
A Note on Community Property States
Several states operate under community property laws. Since community property laws affect the ownership of assets, living – or having lived – in a community property state will come into play in your estate planning process.
In community property states, ownership of a married couple’s assets is defined based on how and when the assets were obtained. Generally:
• Assets obtained prior to marriage are owned as separate property by the spouse who obtained them. • Assets obtained by gift or inheritance during marriage belong to the person who received them. • Other assets obtained during marriage are owned 50/50 by each spouse, regardless of which
one earned or purchased it.
The rules of community property are extremely important when calculating estate tax liability. When a person living in a community property state dies, that person’s estate consists of 100% of his or her separate property and 50% of the value of assets owned as community property.
If desired, many community property states allow husbands and wives to enter into agreements that transfer property from individual or community ownership to the other.
Your financial professional can let you know which are currently community property states. If you are a community property resident, as in most estate planning situations, professional advice can help you achieve your goals within your individual circumstances.
Not a “One and Done” Situation
Estate planning is not something you can do once and then forget about. Your life can change, tax laws change, and tomorrow’s needs may not be the same as today’s. Your estate plan is too important to simply sit back and watch it become obsolete. It is a good idea to conduct an annual review of your entire plan with any professionals you have involved.
However, certain events may cause you to revisit your plan more frequently. Such things include:
• Significant increase (or decrease) in estate value • Birth or death of a family member
• Marriage or divorce
• Change in job or job status if you are not yet retired
G L O S S A R Y
Applicable The applicable exclusion amount is the value of an estate that the federal government allows Exclusion Amount: to be transferred without estate taxes. Estates valued above the applicable exclusion amount
are subject to transfer taxes.
Community Community property laws, effective in several states, define the ownership of assets between Property Laws: husband and wife based on how and when the assets where obtained. Generally, assets
obtained before marriage are owned as separate property by the individual. Assets obtained during marriage, except by gift or inheritance, are owned by the two, 50/50.
Credit Shelter Trust: A trust that utilizes an individual’s applicable exclusion amount.
Durable Power of Attorney: A document authorizing someone you select to act on your behalf. The agent is authorized to act even after the principal becomes incapacitated.
Executor: The person and/or corporation named to execute the terms of a will.
Gift and Generation Gifts by an individual above a certain amount are subject to a federal gift tax. The amount varies Skipping Transfer Taxes: by year and is subject to change. If the gift is to an individual more than one generation
removed, it may also be subject to the generation skipping transfer tax. Gifts by couples can be combined to essentially double the annual gift exclusion.
Healthcare Power of Attorney The person who makes decisions regarding your medical care should you be unable to. or Healthcare Proxy:
Irrevocable Life An irrevocable trust which removes life insurance proceeds from the insured’s estate, making Insurance Trust (ILIT): the death benefit income tax-free and estate tax-free. There may be federal gift tax consequences
associated with the funding of an ILIT.
Living Will: A legal document that states your preferences for medical treatment should you become incapacitated.
Probate Court: A legal proceeding for assigning and/or validating the distribution of a deceased person’s assets.
QTIP Trust: A Qualified Terminable Interest Proper ty Trust is a form of marital trust that allows someone to provide for a sur viving spouse while protecting the inheritance interests of children.
Revocable Living Trust: A legal document, if properly planned, that can help distribute certain assets without having to go through the full probate process.
Survivorship Access Trust: A irrevocable life insurance trust that is drafted in such a manner so that one of the assets owned by the trust is a sur vivorship life insurance policy, through which one insured can enjoy access to the policy’s cash value during his or her lifetime, without causing the inclusion of the death benefit in the estate of either insured.
Universal Life (UL): With universal life insurance (a type of permanent insurance), premiums – net of expenses and charges – are applied to the policy’s account value, which earns a variable interest rate with a guaranteed minimum.
Economic Growth and Tax Relief
Reconciliation Act of 2001 (the “Act”)
The Economic Growth and Tax Relief Reconciliation Act of 2001 (the “Act”) repealed the Federal estate tax and replaced it with a carryover basis regime effective for estates of decedents dying after December 31, 2009. The Act also repealed the generation skipping transfer tax, but not the gift tax for transfers made after December 31, 2009. The Act contains a sunset provision, which essentially returns the Federal estate, gift and generation skipping transfer taxes to their pre-Act form, beginning in 2011. Repeal may or may not become permanent between now and then.
During the period prior to full repeal, the Act provides for periodic decreases in the maximum estate tax rate coupled with periodic increases in the unified credit exemption amount.
About The Hartford®
Founded in 1810, The Hartford Financial Services Group, Inc. (NYSE: HIG) is one of the nation’s largest investment and insurance companies with international operations in Japan, Brazil and the United Kingdom. With 2006 revenues of $26.5 billion, The Hartford was ranked 82nd on the 2006 Fortune 100 list. To millions of customers – businesses, groups and individuals – The Hartford’s stag logo is a trusted symbol of dependability.
The Hartford meets a wide range of life insurance needs with a complete line of cost-effective, innovative life insurance products, Life insurance policies are issued by either Hartford Life and Annuity Insurance Company or Hartford Life Insurance Company. Both companies maintain high ratings from independent rating agencies. Ratings apply to the issuing company and its general contractual obligations. They do not apply to any product.
The Har tford is The Har tford Financial Ser vices Group, Inc. and its subsidiaries, including the issuing companies of Har tford Life Insurance Company (HLI) (New York) and Har tford Life and Annuity Insurance Company (HLA) (Outside New York), Simsbur y, CT. The mailing address for both issuers is P.O. Box 2999, Har tford, CT 06104-2999.
This information is written in connection with the promotion or marketing of the matter(s) addressed in this material. The information cannot be used or relied upon for the purpose of avoiding IRS penalties. These materials are not intend-ed to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice.
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