Stanley - The family fortune and how to protect it

Part 1 of a 2-part series

Years ago people used to talk about the family fortune. They wanted to create the family fortune, protect it, and pass it along to their heirs.

While those objectives may still endure, changing tax laws and a roller-coaster economy have made them more difficult to achieve, especially for baby-boomers sandwiched between aging parents and growing children.

Meeting current income needs, saving for college, planning for retirement, and providing financial and emotional support to Mom and Dad make it difficult think about leaving a legacy.

But, you can still provide for your family with an irrevocable life insurance trust (ILIT), and the assets are usually free of income tax, free of transfer taxes, and protected from the claims of creditors for generations to come.

The ILIT has been around for a long time. In the past, ILITs were often established to provide cash pay estate taxes and other death costs. But, in an era when the future of the estate tax is in doubt and giving future generations a "leg up" is more important than ever, the ILIT can be a great tool in providing for your family.

This article, the first of two, looks at legal considerations of ILITs. A follow-up article considers the tax issues.

Getting started

The ILIT operates much like other trusts with a grantor, a trustee, and one or more beneficiaries. An ILIT is formed by having your attorney draft a trust document and by contacting your insurance agent to apply for life insurance. Not every attorney is qualified to draft an ILIT. Get a referral to someone who specializes in estate planning.

Of course, life insurance is the basis for the ILIT. The key is that the younger and the healthier you are, the more likely it is that you'll qualify for life insurance and can afford to buy all you want. Since youth and good health tend to go together, the sooner you apply the better.

As a general rule, since you want to be sure that the life insurance remains in force until you die, cash value life insurance can be a more attractive option than term insurance. Talk to your agent to decide which policy is best suited to your temperament and needs. The insurance may insure only your life or both you and your spouse's life.

Although joint survivor life policies usually have lower premiums than traditional single-life insurance, these are usually more appropriate when the surviving spouse is likely to have income from other sources following the death of the first spouse.

The trust in action

The trustee may be an individual or a bank or trust company that offers professional trust services. A common arrangement is for a trusted individual to act as trustee while you are alive with a professional trustee stepping in when the death benefit is paid. This saves trustee's fees, but assures competent asset management after you're gone.

The trust may be funded or unfunded. A funded trust contains assets in addition to the life insurance policy. To the extent the assets are income-producing, the income may be used to pay part or all of the policy premiums or provide income to trust beneficiaries. A common approach is to allow the trustee to spray income and principal to the beneficiaries as the trustee sees fit.

The sole asset of an unfunded life insurance trust is a life insurance policy. Because no income is generated by the trust, you either pay the premiums on behalf of the trust or make gifts to the trust sufficient to enable the trustee to pay premiums. For subtle tax reasons, most advisors favor cash gifts, but either approach gets the job done.

By definition, the ILIT is irrevocable. This means that you can't revoke or modify the trust at any time or for any reason. On the surface this suggests a rigidity and loss of control. But your attorney can provide the trustee and beneficiaries with discretionary powers that create tremendous flexibility over the long term.

After your death

Following the insured's death, the trustee collects and invests the life insurance proceeds. Dispositive provisions in the trust determine how income and principal are distributed. If you want a portion of the proceeds to go to charity, just say so in the trust document. If you have a special needs child, make special provision for her.

If you want the trust assets to be available for college education, the purchase of a first home, or the acquisition of a business, just write it into the trust. If you want to be sure that a certain beneficiary doesn't squander his share, build in a spendthrift clause that limits distributions to a big spender and protects trust assets from claims of the beneficiary's creditors.

Although most states have laws that limit the number of years that a trust may endure usually the lifetime of living beneficiaries plus 21 years a few states allow the trust to continue for as long as you like.

These "Dynasty Trusts" benefit family members and selected charities for years into the future. Talk to your attorney about what makes the most sense for you.

Finally, if the trust is properly established, so that the grantor can't benefit from it, the trust assets should be outside the reach of the grantor's creditors. In a world where all of us are exposed to the potential of large lawsuits with both compensatory and punitive damages, the value of asset protection cannot be underestimated.

Conclusion

The ILIT offers benefits that are hard to pass up asset protection, flexibility and continuity. The starting place is to contact your financial professional, meet with your attorney, and get going on the insurance application.

Life insurance policies contain exclusions, limitations, reductions of benefits and terms for keeping them in force. Your licensed financial professional can provide you costs and complete details.

Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603)