If you’ve ever contemplated establishing a Revocable Living Trust as part of your Comprehensive Estate Plan you probably considered avoiding probate as one of the principal benefits. While it is true that, properly structured and funded, living trusts do indeed avoid probate there are many more important reasons to make it the centerpiece of your dispositive plan.
In fact, avoidance of probate, especially with life insurance, seems like a belt and suspenders approach at best and a completely unnecessary complication. Anyway, we’ve all been taught that assets that pass by beneficiary designation don’t go through probate, right? Well, more about that later. For now, let’s focus on the top reasons your Trust should always be the beneficiary of your life insurance.
1. Protecting the Inheritance for Certain Beneficiaries
One of the most important yet least discussed reasons for making the Trust the beneficiary of life insurance, is that in many cases the intended beneficiaries are simply unable to handle the inheritance. When most of us think about planning our estate we intend to give our property to our husband or wife and our children.
Surviving Spouse as Beneficiary:
Naming a spouse is a common practice. However, if your spouse is or becomes unable to handle financial matters, or you and your spouse divorce, then you will need to review your beneficiary designation to make sure that it is still appropriate. More about whether this is ever the best idea later.
Minor Children as Beneficiary:
While you may name your minor children as your designated beneficiary, we will be unable to pay the life insurance proceeds to your children until the earlier of:
• The date that your children reach the age of majority (usually age 18 or 21, depending on applicable state law).
• The date that a legal guardian of the minors’ estate has been appointed by a court. This appointment process can be costly, and state laws may limit who may be named a guardian of an estate. Generally, a guardian of the minors’ estate will hold the money for their’ benefit until they reach the age of majority, usually age 18 or 21, depending on state law.
We all cringe when we hear stories about the 18-year-old that receives a large sum of money, immediately heads out to buy a new expensive car and goes on a two-month party binge with a dozen of his closest friends.
But it’s not just the newly minted adults that lack the skills to properly handle large sums of money. Some may just be spendthrifts that have never been financially responsible. Others may be in a less than rock solid marriage or going through bankruptcy at the time the insured departs this mortal plane.
Unfortunately, the grieving widow is often prayed upon by less than honorable suitors leaving her and the insured’s children high and dry after the money’s all been spent. Then there are those who have special needs or are currently receiving some form of government benefits that would be disqualified by receipt of an outright inheritance.
Perhaps an example here would provide some clarity.
Let’s imagine a scenario where a husband and wife are in a car accident in which the husband is killed and the driver of the other car is seriously injured. Further assume that the wife was at fault and the other driver sues and receives an award of $500,000 in excess of the auto insurance policy liability limits of the husband and wife. If the couple had a $500,000 life insurance policy on the husband to provide for his wife’s and their children’s living expenses with the wife as the primary beneficiary, all those funds would be immediately available to satisfy the wife’s judgment creditor potentially leaving the family penniless.
Or consider this fact pattern. Let’s assume you have an only child, a 19-year-old daughter who is a sophomore in college. Both husband and wife die. If you are like the vast majority, you’ll want your daughter to receive all your property. But the question is, is it wise to reduce all the assets to cash and write her a check for let’s say $750,000. Wouldn’t it be prudent to create a trust for her benefit, properly structured to ensure that her educational expenses would be taken care of along with her general living expenses and any other items that you specify in the Trust. The Trustee which could be a trusted friend, family member, attorney, CPA, local bank, financial advisor or some combination, who would manage and invest the trust. The Trustee would hold the funds for your daughter’s benefit until she reached a more mature age say 25 at which time all or a portion of the inheritance would be made available for withdrawal. It may be your desire to permit a series of withdrawals available at various ages, for example 1/3 at age 25, 1/3 at age 30 and the remainder at age 35.
Dependent upon your personal financial philosophy you may even determine that it is best to keep the property in trust for her lifetime while providing the flexibility for the trustee to purchase property to be used by her as a family home, and living expenses or even investing in a business, providing for lifetime asset protection for your daughter against future creditors or the claims of a divorcing spouse.
Trusts have been used to protect property this way for hundreds of years. Asset Protection is arguably the primary reason to establish and utilize one today.
2. Stuff Happens
Unfortunately, life doesn’t typically bend itself to your planning. People don’t always die in the order that we expect and when that happens the typical primary beneficiary, contingent beneficiary designations that many advisors recommend simply don’t work.
For an example consider the following fact pattern. John Doe has a $1,000,000 life policy with his wife, Mary Doe as the primary beneficiary and his 3 children as contingent beneficiaries who are to receive 1/3 each. The oldest son Matt, age 25, is killed in an automobile accident along with his mother Mary Doe. He leaves a wife and two children ages 2 years and 9 months and is survived by his younger brother Tim and sister Ruth ages 21 and 17 respectively.
John dies 1 year later but never thought to change the beneficiary designations on his life insurance. What happens? Stuff happens! and it is probably stuff that John, had he thought about it, wouldn’t have wanted.
Tim receives a check for $500,000 immediately.
Ruth’s $500,000 is held in a guardianship account for a year until she reaches age 18 at which time she receives a check for $500,000 plus earnings outright.
Matt’s widow receives nothing!
3. Blended Families
“Modern Family” is a TV show that is typical of many blended families today. Jay has two grown children and four grandchildren. Jay and his second wife Gloria have a son together and Gloria has a son from a previous marriage. Oh, and did I mention that his new wife is close in age to his children.
Once you have been through a divorce you understand that “till death do us part” may not be how the story ends. You want to take care of your spouse, children, and grandkids but leaving it to them to work it out or counting on your spouse to be fair, is both unfair to the surviving spouse and potentially a recipe for disaster.
The biggest issue for blended families is that your spouse may, over the years, decide not to leave anything to your children from a previous marriage. Additionally, in the case with a much younger new spouse, it’s quite possible that he/she could live for as long or longer than their age contemporary step-children. Life insurance proceeds left in a well thought out trust can avoid the very real conflict that could easily, and probably will, ensue with a simple beneficiary designation dispositive plan.
The Estate as Beneficiary
If life insurance proceeds are payable to the decedent’s estate, the beneficiaries of the estate won’t receive the proceeds until a legal process called “probate” is completed. By naming a beneficiary other than the estate, the life insurance proceeds can be paid to a designated beneficiary almost immediately after a claim for life insurance benefits has been filed and without having to go through the probate process.
In addition, naming the estate as the beneficiary of life insurance proceeds may subject them to the claims of the decedent’s “creditors” (i.e. people and institutions to whom they owe money). This means there may be less money to distribute to the heirs under the Will.
Life insurance proceeds payable to a designated beneficiary other than the decedent’s estate will generally not be subject to the claims of his/her creditors.
Estate Planning 101 teaches us about the various ways property passes upon death. Probate is typically not necessary if property is passed by operation of law, i.e. joint ownership of property with rights of survivorship. Probate is also not required if property is passed by beneficiary designation. Life insurance, qualified plan proceeds, annuities, Pay on Death or Transfer on Death accounts are a few examples. These are all typically seen and often used in implementing a dispositive plan for a decedent.
However, all these methods of property transfer on death have one thing in common – they are all unrestricted outright transfers. At the moment of death, all rights in the property are vested in the beneficiary or the joint tenant and likewise subject to the recipient’s creditor’s claims or to the whims of a spendthrift beneficiary.
They are also potentially subject to probate! Unless the recipient of the life insurance proceeds take affirmative steps to do their own planning the proceeds will be subject to probate on their subsequent death. While there are certainly actions that can be taken to avoid the subsequent probate, payment of the life insurance proceeds into a trust would have made those actions unnecessary.
5. Estate Taxes
Federal estate taxes must be paid if the net value of an estate at death is more than the amount exempt at that time. Currently the federal exemption is $11,180,000, adjusted annually for inflation. Some states also have their own estate or inheritance tax, so it is possible that the estate could be exempt from federal tax but have to pay a state tax.
If the estate will not have to pay estate taxes, naming a living revocable trust as beneficiary of the policies will give the trustee control over the proceeds. It also ensures that the court will not be able to control the proceeds if a beneficiary is a minor, incapacitated or no longer living when the insured dies.
If the estate will be subject to estate taxes, it would be better to set up an irrevocable life insurance trust and have the trust own the policies. This will exclude the value of the insurance from the decedent’s estate, resulting in reducing the size of the estate and any estate taxes owed so more can be left to the beneficiaries.
Consider the restrictions on transferring existing policies to an irrevocable life insurance trust. Should the owner die within three years of the transfer date, the IRS will treat the transfer as one made in contemplation of death and the value of the insurance will be included in the estate for purposes of calculating the estate tax. There may also be a gift tax. These restrictions, however, do not apply to new policies purchased by the trustee of this trust.
6. Inheritance Taxes
As the saying goes: The exception makes the rule. At this writing (2018) there are still six states the impose an inheritance tax.
It is possible that life insurance proceeds paid to a trust may not qualify for the inheritance tax exemption provided by some states for insurance payable to a named beneficiary. Check with your tax advisor, run the numbers and then weigh the many advantages of naming the Trust as beneficiary of the life insurance policy against the potential tax hit.
7. What About Community Property States
If you live in a community property state – (Arizona, California, Idaho, Nevada, New Mexico, Texas, Washington or Wisconsin) your spouse may have a legal claim for a portion of the life insurance benefit under state law. If you name someone other than your spouse as beneficiary, payment of the life insurance benefit may be delayed until your spouse’s claim is resolved. If you make the beneficiary someone other than your spouse, including your revocable living trusts, it may be a good idea to get a signed statement from your spouse waiving his or her rights to any community property interest in the benefit.
8. But I Don’t Have A Trust
One of the chief reasons that people don’t name their Trust the beneficiary of their life insurance is they don’t have a Trust. A valid, legal trust must exist at the time of your death to be the beneficiary. Life insurance proceeds which are distributed to a living trust will avoid probate. Testamentary trusts are drafted as part of a will and take effect after the death of the grantor. Proceeds distributed through a testamentary trust pass through the “probate” process after the grantor’s death because the trust is included in the will.
That leads us to the next logical question of “why no trust?” It is estimated that 64% of Americans don’t even have a simple will and 90% do not have an up to date comprehensive estate plan.
When asked why they haven’t put a plan in place 27% said there wasn’t an urgent need and 15% said they didn’t need one at all. Most said they just hadn’t gotten around to it yet but that isn’t all. Most people don’t like to think about death and quite a few believe that by planning their estate they may be hastening their own demise. Think about the saying, “I’m so far behind I’ll never die.” A significant number falsely believe that estate planning is only for the rich with a multimillion-dollar net worth.
For those that acknowledge the benefits of planning, cost and complexity top the list of reasons for not having their essential documents in place. And when you consider that sitting down with an estate planning attorney for hours discussing their personal finances, intimate personal relationships, health concerns and their own ultimate demise, knowing that they will probably end up spending thousands of dollars for a pile of documents they don’t really understand, can you blame them.
Interactive Estate Document Systems (ieds.online) was created to address those concerns. The goal was to provide the highest quality estate planning documents and client education to enable our clients to fully understand the options available to them as they move through the estate planning document formulation and creation process.
While the entire IEDS process is simplistic, easy and intuitive, the questionnaire is dynamic, state specific and attorney drafted to ensure the completed assembled document set is accurate and fully legal. It utilizes highly intuitive, context sensitive, question and answer dialogs for the preparation of quality customized documents.
This is the same document assembly software that I utilize in my private law practice and is constantly kept up to date with changes to state and federal law.
Pricing is straightforward and reasonable with a Couple Revocable Living Trust Package available for $750 and a Single Revocable Living Trust Package available for $500.
A Custom Law Firm Quality Probate Avoidance Living Trust
Declaration of Trust
Certification of Trust
Assignment of Personal Property Instructions for the Distribution of Personal Property
Durable Power of Attorney Advance Health Care Directive, (which includes a Living Will)
Last Will and Testament (including guardian nomination if needed)
HIPPA Authorization and Waiver Final Disposition Instructions (i.e., “Burial Instructions”)
Instructions for Transferring Assets to the Trust
The Completed Transfer Document Templates
One Year of DocuBank Online Document Storage with 24/7 access to Advance Health Directives
Unlimited Revisions for the First Year (with an optional maintenance plan for $9.00/mo)
During my years as a financial planner I had a trainer that constantly reminded us that everyone favorite radio station was WII-FM also known as What’s In It For Me. Let’s talk about that for just a moment.
Why are you in your profession? Is it just to make a paycheck? If you are like most insurance agents and financial advisors that I’ve had the privilege of working with for the past 3+ decades, it’s not just about the money. Sure, you work and get paid. We all do that. But to make it in this business and stay in this business, it takes a special type of person, someone with a passion for helping others reach their goals and protect their future, for them, and those they care about.
You probably enjoy having person to person contact in this social-media-driven world that requires that you have honest conversations with your clients and prospects that requires you to engage on a person to person level. The more active relationships and the deeper those relationships you develop become the more you will be able to take advantage of passive contacts, expanding your business through recommendations and referrals by your clients to friends and family or colleagues looking for a trusted advisor.
Comprehensive financial and estate planning involves much more than selling someone a product, even if that is the best product ever made. Without the proper estate planning documents, without the proper asset titling and beneficiary designations, without the caring guidance of a trusted advisor urging the client to take timely action all could be lost. Your advice is a big part of what keeps them all moving toward their financial goals, and the value of that can’t be overstated.
At the end of the day, insurance agents and financial advisors are a lot like teachers in the best possible way: you’re helping people learn and grow in an area they don’t know a lot about to ensure that they’ve got the best chance at having the future they dream of. It’s a calling that takes a special kind of person to do, and you might feel a little like a hero, going out there every day and helping people protect and achieve their futures.
During your training you were probably taught to explain to your prospect the concept of the multidisciplinary team approach and your goal was to be the quarterback, the go to guy who would coordinate and interface with the other allied professionals. Who are those guys? The accountant or CPA and attorney are two of the usual suspects. Other players may be a trust officer, investment manager, financial planner, charitable giving planner, and of course the insurance agent. In many cases multiple roles are filled by the same person, in others many players may be involved.
Two things may happen at this point assuming the client does not already have estate planning documents.
1. The client doesn’t have an attorney. In this case you may have developed a good working relationship with an estate planning attorney to whom you can refer the client to have the comprehensive estate documents prepared. You are pretty sure that the legal costs are going to run anywhere between $3,500-$10,000. You are convinced that the client would benefit from the work but suspect that the cost objection will rear its ugly head. This puts your advisory relationship at risk. Though nothing is ever overtly stated, the client for some mysterious reason simply stops moving forward, not only with the estate planning documents but also with the insurance recommendations.
2. The client has an attorney but he’s not an estate planning attorney. He may or may not support your insurance recommendations. You don’t know. You do know that the client doesn’t have estate planning documents in place because you’ve asked. Why doesn’t he have them? Again, cost or complexity. He needs them. You know it and so does he. Regardless of his financial condition he’s still reluctant to spend big money on estate planning documents. Furthermore, every dollar he spends on his documents reduces the dollars available to fund the life insurance or other products that he needs.
Why not take this opportunity to provide your client with real value? While there are certainly cases where the need for the input and counsel of an estate planning attorney are not only prudent but essential, in most cases today, use of a sophisticated document drafting system is the better course. In much the same way that TurboTax® revolutionized the way individuals handle their tax return preparation, today’s dynamic-response interview-based drafting guides and document assembly software enable the creation of truly personalized comprehensive estate planning document packages at a fraction of the cost of using an estate planning attorney.
Another reason for getting more deeply involved in your client’s estate planning implementation is the simple fact that during the typical implementation process an additional 5-8 individuals are identified as potential prospects. Guardians and their alternates, Trustees and their successors, beneficiaries and other trusted friends and advisors are all named and close to your client. Odds are that just as you are providing valuable assistance to your client, many of these individuals are in the exact same situation, needing the products, advice and assistance you offer.
Do well by doing good. Help your client get the comprehensive estate planning documents they need and make sure the beneficiary designation is to their Revocable Living Trust that has been drafted in specific accord with their dispositive wishes. Everyone benefits.