Quick, what demographic group in America is spending more and making more financial decisions? While it may come as a surprise to some, it is the record number of grandparents who “are younger, financially comfortable, and bestowing a good deal of their money on grandchildren,” according to the new MetLife Report on American Grandparents.
You may even be part of this growing demographic yourself, a majority of whom are working-age baby boomers between 45 and 64 years old. Many in the grandparents demographic are 55 and up, and they are increasing their spending on things such as primary and secondary education to a higher level than any other point in history.
All in all, the grandparent demographic is demonstrating concern and love for grandchildren by their monetary actions. As grandparents attain more financial security, the opposite can be true for their children, who may well be confronting a range of economic challenges. In many cases, this is where grandparents step in to provide a financial backstop.
For grandparents seeking to provide their grandchildren with a legacy of financial security, life insurance can be a good financial option. In particular, there are three practical ways in which clients that fall into the growing grandparents demographic can leverage life insurance to transfer significant wealth to grandchildren in this current environment.
Window of Opportunity
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the Act) has created an important window of opportunity for wealth transfer. The gift, estate and generation skipping transfer tax (GSTT) exemption has been raised to $5 million and the top tax rate has been set at 35 percent through 2012.
The $5 million gift, estate and GSTT exemptions and top 35 percent rate are scheduled to expire at the end of 2012, so more affluent individuals still have an opportunity to review their existing estate plans and consider making lifetime gifts which can be further leveraged through the use of life insurance.1
The Insurable Grandparent
One important way that life insurance can be used to provide financial protection for grandchildren is for a grandparent(s) to purchase single life or survivorship coverage for the ultimate benefit of their grandchildren. The client’s goals and situation control how the policy is owned. For instance, the size of the premiums, cash values and death benefits along with creditor protection and estate tax issues will often dictate whether the policy is owned personally, by a revocable living trust, or by an irrevocable life insurance trust (ILIT).
If the coverage is owned personally or by a living trust, the grandparent retains access to the policy’s cash values but, perhaps more importantly, this approach preserves the power to change the beneficiary of the policy’s death benefit.
Since naming a policy’s owner and beneficiary designation is an extremely important planning decision, it always makes sense to have the client’s attorney review these decisions on a periodic basis in order to incorporate the insurance gift under the estate plan and to avoid a myriad of potential tax or legal problems that can arise.
Although personal ownership or policy ownership by a revocable trust may make sense when access to the policy’s cash values or control over the death benefit is desired, many affluent clients choose to have their policy held by an ILIT. This can be an effective technique to transfer wealth to one’s children and/or grandchildren because the policy’s death proceeds are usually not subject to estate taxation, and the policy is usually beyond the reach of the insured’s creditors.
Creditor protection laws vary dependent upon governing federal and state law. Individuals should be sure to confer with their independent tax and legal advisors regarding how applicable laws apply to their particular situation.
If wealthier individuals are seeking to create a multi-generational estate plan, they may wish to establish a special type of ILIT referred to as a dynasty trust. This is a special type of ILIT that is designed to provide income and/or principal to multiple generations (e.g., grandchildren, great-grandchildren, etc.) consistent with the time permitted under state law.
Dynasty trusts are sometimes designed to leverage lifetime cash gifts into significant policy death benefits while sheltering trust assets from ongoing estate taxation. A significant window of opportunity currently exists for clients wishing to utilize their $5 million lifetime and GSTT exemption.
Insuring the Parent(s)
A second way for a grandparent to provide financial protection or wealth to grandchildren is to fund a policy that insures one or both of the grandchild’s parents. Depending upon the goals involved, this coverage may be owned by the parents or by an ILIT established for the benefit of the grandchildren.
Insuring the parents can be a very attractive alternative when grandparents are very old or uninsurable or when parents are underinsured or would benefit from some help funding some or all of the policy’s premiums. In designing coverage purchased on the parents, consider the grandparents’ specific testamentary bequests in order to fund some or all of any remaining premium payments.
Insuring the Grandchild
Another possible way that a grandparent can provide financial protection to a grandchild with life insurance is to fund a policy insuring the life of the grandchild. The coverage may be owned by the grandparent, an adult grandchild, a custodial account, or by a revocable or irrevocable trust.
Some advantages of juvenile coverage are: The grandchild’s insurability is established early in life before any health issues may arise. Cash values under permanent policies have a longer period to accrue and, when properly structured and funded,2 can be used for a variety of important lifetime needs (e.g., educational expenses, a down payment on a house, or retirement). Death benefits can be used to provide wealth and protection for the grandchild’s family.
Designing the Life Insurance Gift
In a constantly changing world, one thing that has not changed is that the love and affection grandparents have for their grandchildren remains a very vibrant feature of our culture. Consider taking time during the estate planning review process to discuss how life insurance gifts established by grandparents can be designed to transfer wealth, provide financial protection and leverage transfer tax benefits available under this current window of opportunity.
Footnotes
1. Individuals considering gifts in 2011 and 2012 should be aware that while such gifts up to the $5 million exemption amount may not result in immediate gift taxes, a portion of those gifts could be “recaptured” and subject to an estate tax when the donor passes away. This may be an issue if the estate tax exemption is lower when the donor passes away than it was when the donor made the gift. Under current law the unified exemption amount will be reduced to $1 million beginning in 2013.
2. Tax-favored distribution assumes that the life insurance policy is properly structured and not classified as a modified endowment contract (MEC). Withdrawals are made up to the cost basis and policy loans thereafter. If the policy is a MEC, cash value is taxable upon withdrawal and if withdrawn before age 591/2, a 10 percent federal income tax penalty may apply. If a policy should lapse or be surrendered prior to the death of the insured, there may be significant tax consequences. Loans and withdrawals will decrease the cash value and death benefit.
