With the expansion of the Federal Estate Tax Exemption to $5 million, I often hear from financial advisors that there is no reason to do an Irrevocable Life Insurance Trust (“ILIT”). Usually in the form of “Guess that business is gone” Naturally we remind everyone that this extension is only for two years and that it could go back to the pre-2000 limit of $1 million.
But let’s assume that the Federal Estate Tax Exemption remains at $5 million for the foreseeable future, there are still reasons for clients to get an ILIT for their life insurance policies. Let’s remember the main reason a person has a life insurance policy is to insure that after they pass away, they are able to leave some money as a legacy for their family. We also know that more and more life insurance products are there to give peace of mind to the insured that they no longer have to worry about living frugally so that they will have no money to leave to their family. Good Financial advisors explain to their clients that they can enjoy their money while they are alive, knowing that their life insurance can leave a legacy to the family. That legacy remains at risk from New York State Taxes and Nursing Home costs unless it is protected in a vehicle such as the ILIT.
New York State has not eliminated its Estate Tax
New York State has always had an Estate Tax and its Exemption amount is $1 million the same as the old federal law. New York State gives a full deduction for any amount paid on the Federal Tax but since anyone with $1 million to $4.99 million will not pay federal taxes, then state taxes apply. The taxes are on a progressive scale but will still meaningful tax bite for any client that falls within this range. If, in 2011, an individual passed away with $2 million, the taxes owed to New York State could be as high as $100,000. Given the State’s financial troubles it is unlikely that they will change that Exemption in the future regardless of what the Federal Government does. Since life insurance is counted as part of the decedent’s Federal Estate Tax calculation, taking the policy out of their estate eliminates this tax burden. That has historically been the goal of the ILIT.
What about nursing home care?
So let’s say you have a client who took your advice and bought a policy of a million dollars so that the client could spend their money on themselves. Ten or fifteen years go by and they have significantly depleted their estate. But there is no need to worry about the kids because there is a million dollar policy for them. However, now the client has Alzheimer’s and will need long term care in the foreseeable future. Their entire plan is at risk because of their long term care needs.
Why - Did you know that Medicaid requires that life insurance policies with a cash surrender value of more than $1,500 must be cashed in before an individual can qualify for Medicaid?
The ILIT can protect the policy so that it is not only taken out of the estate for tax purposes but also taken out of the estate for Medicaid purposes. This protection should be done sooner than later because unlike the gift provisions for the IRS, the transfer of the policy for the ILIT is subject to the five year lookback rule. However, even if the client is looking at a long term care issue in less than five years it is still possible to protect the policy as long as there are other assets with which the client can privately pay.
Historically the greatest threat to legacy preservation was the tax bite of the federal estate tax but more recently, especially for the middle class, the threat of losing one’s asset to nursing home costs is becoming highest concern on the minds of many clients.
As an estate planning attorney more and more of my practice is devoted to the creation of special Medicaid trusts that allow my clients to qualify for government assistance for long term care while protecting their hard earned assets for their family. The ILIT can be an important part of any estate plan or asset protection plan.
So before we declare the ILIT dead, remember, understanding a client’s concerns and the purpose for the estate plan means there still are reasons to place an insurance policy in an asset protection trust.
If you have any questions about ILIT’s or any other estate planning issues, please feel free to call me at 914-862-0580 or 845-368-0845.