RJS 9-27-25

Episode Transcript

Speaker 1 (00:00):
Good morning to all. Craig Shillig here and this is
Safe Money. I'm here every Saturday to talk with our
listeners about financial strategies we use to manage and protect
assets safely. I've been an insurance agent for over twenty
four years. During that time, I've learned a few insurance strategies,
like using annuities as safe money harbors, or using cash

(00:22):
value life insurance to supplement retirement income. Just a reminder,
you can call our office at five six three three
three two two two zero zero if you'd like to
enroll into one of my virtual Medicare community meetings I
give two every month via zoom, or you can email
me at Craig at Craigshillig dot com and that's my name,

(00:46):
cr Aig at cr AI G S c h I
l LIG dot com. September is Life Insurance Aware month.
Today I'd like to continue my talk about life insurance,
specifically in irrevocable life insurance trust, also called an islet.

(01:11):
What is an islet? An irrevocable life insurance trust, sometimes
referred to as a wealth replacement trust, is a trust
that is funded at least in part by life insurance
policies or proceeds. If properly implemented, an islet can help
minimize the state taxes and provide a source of liquid

(01:32):
funds to your estate for the payment of taxes, debts,
and expenses. Generally, assets you own a death are subject
to federal estate tax. This includes life insurance policies and proceeds.
The states in access to the appical exclusion amount, which
this year is thirteen point call it point nine to

(01:57):
nine million. Any deceased spouse unused exclusion amount. In twenty
twenty six that number will be fifteen million, but they
may have to pay a state taxes at rates as
high as forty percent. If you're an insured individual who's
the state will have to pay a state tax, your

(02:19):
family may receive less money from your life insurance than
you originally planned for. An islet can solve this problem,
and maybe especially appropriate if your state would not have
to pay a state taxes were it not for the
inclusion of the policy proceeds. So how does an islet work?

(02:40):
Because an irrevocable life insurance trust, sorry, because it is
an irrevocable trust, policies and proceeds and any other assets
held by the trust are considered owned by the trust
entity and not owned by you. Since you won't own
the policy at your death, the proceeds will not be

(03:02):
included in your estate. They will be received by the
islet and ultimately pass to your family members undiminished by
estate taxes. Your family members can use the proceeds to
pay estate expenses. This may save your family members from
having to sell assets at fire sale prices and allow

(03:24):
them to keep assets that may generate needed income or
our value family keepsakes. One key to the strategy is
that you must relinquish all power, all power over and
benefits from their property in the trust. You have to
give up control. In a typical scenario, a ensurable person

(03:49):
the grant or creates an islet. He names an independent
trustee like a bank trust officer, and names the beneficiaries
of the trust, usually is spouse and or children. The
trustee then applies for life insurance on the granter's life
and designates the islet as the sole beneficiary. The trustee

(04:11):
also opens a checking account for the islet. The grantor
gives the trustee funds for the initial premium, which the
trustee deposits into the islet. Checking account. The trustee writes
a check from the islet checking account, pays the premium
to the insurance company, and coverage becomes effective as premiums

(04:32):
come due. The grantor and trustee repeat the same procedure
whenever the islet receives funds from the grant tour. The
trustee provides a special notice a crummy notice, to each
of the beneficiaries. The crummy notice lets the beneficiaries know
that they have a right to withdraw the recently deposited funds,

(04:54):
but only within a certain limited of time ie. Thirty
to sixty days. The trustee waits until his timeframe passes
before remitting the funds to the insurance company. This notice
procedure serves to qualify the gift for the annual Gift
Tax Exclusion the GST. At the granner's death, the islet

(05:14):
trustee collects the total proceeds and distributes them to the
beneficiaries according to the terms of the trust document. So
why would we use an islet? There are many reasons
to use a trust rather than have an individual own
your life insurance policy. For example, having your spouse own
the policy may defeat the purpose of the islet as

(05:36):
the proceeds will be subject to estate taxes in his
or her estate. Having an adult child or any other
individual owned the policy may expose the policy or proceeds
to the individual's creditors, or may create disharmony among family members.
An islet can accomplish some are all the following. Can

(06:00):
avoid inclusion of the proceeds and or your spouse's estate.
Make the cash liquidity provided by the total proceeds available
to the estate of the insured, Insulate the proceeds from
the estate taxes over multiple generations, Provide professional management of
the proceeds, protect the policy in the proceeds from future

(06:23):
creditors and potential ex spouses. It can also provide incentives
excuse me incentives for beneficiaries. So let's talk about creating
an islet. The trust must be irrevocable to enjoy its benefits.
A life insurance trust must be irrevocable. That means the

(06:45):
grantor can't change the terms of the trust or the
beneficiaries in the trust, or retain any power over or
interest in the trust. Further, any property transfers made to
the trust must be complete and permanent. This also applies
to the spouse if the islet is funded with a

(07:06):
second to die policy. So let's talk about naming a trustee.
Your choice of trustee, the person who administer the trust
is an important decision for the islet to be effective.
You cannot service trustee and you shouldn't even retain the
power to name yourself as trustee. The IRS is clearly

(07:27):
stated their proceeds will be included in an insurance a
state if the insured serves as trustee. If the ISLT
holds a second to die policy, your spouse cannot service
trustee for the same reason. A non insured spouse can
service trustee, but it's not recommended. Remember, one key to

(07:49):
an island is relinquishing all control over in interest in
the trust property. If your spouse is administering the trust,
you may be regarded as retaining some control, albeit indirectly.
If you choose this course, however, your spouse must not
make any gifts to the trust. If your spouse is

(08:10):
also a beneficiary, a coast trustee is recommended to handle
distributions to your spouse, or a successor trustee should assume
all duties at your death. Other beneficiaries can serve without
adverse tax consequences, but this is generally not a good
idea because they may be there may be conflicts of interest.

(08:35):
Other non beneficiary family members or friends can serve as
long as you trust them to perform their duties competently.
A professional trustee may be the best choice because a
professional will have the experience to probably administer your islet,
and you can be fairly assured of competent asset management

(08:57):
and impartiality. The key duties of an island trustee include
opening and maintaining a trust checking account, obtaining a tax
payer identification number for the trust entity, applying for and
purchasing life insurance policies, accepting funds from the grant or

(09:18):
sending crummy withdrawal notices, paying premiums to the insurance company,
making cash value investment decisions, claiming insurance proceeds at your death,
distributing trust assets according to the terms of the trust,
filing for tax returns if necessary, naming the beneficiary to

(09:42):
heap the proceeds out of your state. Do not name
your executor, your estate, your creditors, or the creditors of
your state as beneficiaries of the trust. The proceeds will
be considered payable to your estate if your islet requires
the trustee to u use the proceeds to pay your
state's debts, taxes, and or other obligations. If the islet

(10:06):
merely gives the trustee the authority to pay such expenses, however,
the proceeds will not be included in your estate unless
the trustee actually uses them to satisfy said obligations. To
make the proceeds available to your estate, the islets should
include language that permits the trustee to buy property from

(10:28):
your estate or make loans to the estate. If the
trustee does either, the transaction must be completed in a
reasonable arms length manner. If you want to name your
spouse as a beneficiary and also keep the proceeds out
of your spouse's estate, the islet must be drafted so

(10:48):
that the access by your spouse to the proceeds is limited.
Your spouse can receive some or all of the annual
income from the islet, but access to the trust principle
must be limited to ascertainable standards examples for support, health
or education uses only. Further, your spouse can hold a

(11:12):
right of withdrawal not to exceed the greater of five
percent of the trust balance, or say five thousand dollars
each year. Your spouse can also be given a limited
or special power of appointment, but not a general power
of appointment. In other words, your spouse can name subsequent beneficiaries,

(11:33):
but cannot aim himself for herself, his or her creditors,
or the creditors of his or her estate. Let's talk
about funding the islet. You can create an islet and
leave it unfunded during your lifetime. An unfunded islet is
one that holds a life insurance policy only and does

(11:54):
not hold any other assets. With an unfunded islet, you
will need to get money to the trust so the
trustee can pay policy premiums. If the trust holds a
permanent life insurance policy and the policy allows it, premiums
can be paid with accumulated cash values or dividends, and
you may not need to gift additional funds. Alternatively, you

(12:19):
can fund an islet during your lifetime with assets in
addition to your life insurance policy. Funding an islet with
income producing assets can provide the trustee with the money
needed to pay the policy premiums. An addition and additional
benefit of funding your islet is that any future appreciation

(12:40):
in the asset will be sheltered from a state taxes. Again,
because the trust is your avocable funding, your islet also
allows you to coordinate the assets final disposition with the
insurance proceeds. After you die, the islet, whether it's unfunded
that are funded, will receive the policy proceeds and the

(13:03):
trustee will administer them according to the terms of the trust.
The trust can receive other assets at your death along
with the insurance proceeds, such as assets poured over from
your will or death benefits paid by your employer or
employer benefit plan. The trust terms can direct that the
proceeds be distributed to the beneficiaries immediately, or the trust

(13:26):
terms can direct that the proceeds remain in the trust
and under the trustees management for a period of time
before being distributed. The latter option may be desire desirable
if you anticipate that your errors might mismanage the funds,
or if your errors are minor. Children let's talk about

(13:48):
the three year rule. You may have existing life insurance
policies you want to transfer to an islet. While this
is possible, merely execute an absolute assignment of ownership form
provided by the issuing insurance ensure. It is not advisable
because transferring existing policies triggers a three year rule. This

(14:11):
rule states that if you transfer life insurance policy to
an islet within the three years preceding your death, all
the proceeds will be brought back into your state for
state tax purposes. Because of the three year rule, it's
not advisable to transfer policies unless you're no longer ensurable,
or if you can't afford the cost of a replacement policy.

(14:35):
You can avoid the three year rule by allowing the
trustee on behalf of the trust to apply for and
purchase a new policy. If the trust owns the policy
from the outset, the three year ruleill not apply because
the purchase must be purely discretionary. Be sure the trustee
is not obligated to buy the policy, but is permitted

(14:56):
to do so. Ship problem To keep the proceeds out
of your state in your spouse's a state, you and
your spouse must not retain any incidence of ownership in
the policies held by the trust. Though the IRS doesn't
specifically define incidence of ownership, the phrase generally refers to

(15:18):
any rights you retain that might benefit you economically. Those
rights include the rights to transfer or to revoke the
transfer of ownership rights, the right to change certain policy provisions,
the right to surrender a cancel a policy, the right
to pledge the policy for a loan or to borrow

(15:39):
against its cash value, the right to name and or
to change the beneficiary, the right to determine how beneficiaries
will receive the death proceeds. You must not retain any
of these rights. Further, the trust documents should expressly state
that the trust is irrevocable and that the insured is

(15:59):
retaining no rights to the policies held by the trust.
Crummy withdrawal rights. Transfers of cash or any other property,
including cash value accumulated and existing policies to your islet
may be subject to gift tax. However, you can minimize
or eliminate your actual gift tax liability by structuring the

(16:22):
transfers so that qualifies for the annual tax exclusion, which
this year is nine thousand dollars per beneficiary excuse me
nineteen thousand dollars for twenty twenty five per beneficiary. Generally,
a gift must be a present interest gift in order
to qualify for the annual gift tax exclusion. This would

(16:44):
allow you to gift nineteen thousand dollars per beneficiary gift
tax free. A present interest gift means that the recipient
is able to immediately use, possess, or enjoy the gift.
Gifts made to a trust are usually considered gift gifts
of future interests and do not qualify for the annual

(17:04):
gift tax exclusion unless they fall within an exception. One
such exception when the beneficiaries are given the right to
demand for a limited period of time any amounts transferred
to the trust. This is referred to as a crummy
withdrawal right of powers. The beneficiaries must also be given

(17:25):
notice of their rights to withdraw whenever you transfer funds
to the islet, and they must be given reasonable time
to exercise their rights. The basic requirement is that actual
written notice must be made in a timely manner. It
is best to give written notice at least thirty to
sixty days before the expiration of the withdrawal period. It

(17:48):
is the duty of the trustee to provide notice to
each beneficiary. Of course, so as not to defeat the
purpose of the trust, your beneficiaries should not actually exercise
crummy withdrawal rights, but should let their rights lapse. Laps
which draw rights, however, consider gifts to the other trust

(18:09):
beneficiaries and are generally includable in a beneficiaries as state.
To address this problem, the Internal Revenue Code provides an
exception referred to as five or five power. The code
states that the lapse of rights to withdraw will not
be treated as a gift. It will not be included
in the beneficiaries of state to the extent it does

(18:32):
not exceed the greater of five percent of the trust
balance or five thousand dollars each year. Because the beneficiaries
withdrawal powers are limited to five percent or five thousand
of the trust assets each year, your annual gift tax
sclusion is also limited to the five or five amount.

(18:52):
If you need to contribute more than this to cover
the policy premiums, the access will be subject to gift tech.
You may be able to avoid this result with the
use of hanging powers. The hanging power throws the access
into future years until all of it is used up.
So there's tax considerations that also fall under this. There's

(19:15):
income tax, there's gift tax, community property considerations, beneficiaries also
may incur a gift tax or a state tax due
to withdrawal right lapses. There's a state taxes involved, the GST,
the generation skipping taxes involved. My point on all this

(19:39):
is going to be you can't do this yourself. You
got to get three or four people involved. You need
an insurance professional, you need an estate tax planning attorney.
You need a good tax accountant to help with some
of this. You got to have a team, So make

(20:00):
sure you get your team together. Trusts income generally are
attributed to the granter. If you find your islet with
income producing assets and the trust is the grant of
the trust, income from the trust will be taxed to you,
and you can use any gains, losses, deductions, and credits

(20:21):
realized by the trust islet. If the trust is not
a granter trust, the income tax rate rules are generally
as follows. Income used to pay premiums as tax to
you the granter. Income paid to the beneficiaries is taxed
to them. Income retained by the trust is taxed to

(20:42):
the trust. Let me see so. Community property considerations. If
you live in a community property state, special attention should
be paid to drafting and funding of your islot. For example,
you should create a separate property agreement and fund the

(21:02):
trust with a separate property. I'm speeding through some of
those because I'm going to run out of time here
a little bit, but a couple of key things here.
People use islets to basically offset what their is state

(21:22):
tax liability is going to be. So, if you own
total assets there are more than let's just call it
fifteen million, you're gonna have to pay in a state tax.
By funding an islet, you can have the islet proceeds
offset that tax and not hinder and or cause problems

(21:46):
to existing current assets, especially if they're in retirement accounts
or Brookrad's accounts or stuff of that nature. Another example
would be, let's say you own a lake house and
you want to transferred to the family. Well, if the
kids can't afford the property, they're going to sell the property.

(22:08):
So if this is a let's just call it a
fifteen million dollar house, in order to keep that house
in tip top shape, that costs x amount of money
a year in order for insurance, taxes and repairs and upkeep,
not to mention a staff to keep it running. If

(22:31):
the kids don't have money to offset those expenses via
life insurance through an islet, they're going to be forced
to sell the property and distribute the proceeds of the
sale depending on how many kids are involved. When you
see some of these giant homes throughout the country, most

(22:52):
of those are funded by dynasty trusts. And what it
is is it's insurance proceeds that are passed down from
general the generation that fund the expenses that go into
those properties. I know you've seen one before. They're out there.
Think of a giant house you've seen, if it's been

(23:13):
in third, fourth, fifth generation, it's probably funded by a
dynasty trust, probably created by an islet. So these are
just some tools out there that can be used. If
you do win the recent lottery ticket I think was
in Chicago for almost a billion, you're gonna want a

(23:37):
few islets and or a trust. You'll probably have separate ones,
but you're gonna want to do that because you're gonna
have an estate tax problem forever if you don't plan
for this. The irs is very simple. They're going to
charge forty or fifty percent of total assets and that's
your tax bill and that's not a picnic. So do
you want to give away half of your assets to

(23:59):
the irs, or do you want to offset it for
pennies against dollars on a life insurance program that can
offset that, So please keep that in mind. Let me
see what else do I got here? Don't forget. I

(24:24):
give monthly virtual meetings regarding Medicare for two different companies
every month. In one meeting, I will cover the Medicare
supplement plan with a standalone drug plan. That meeting is
sponsored by Willmark. United Healthcare is a sponsor. For my
other virtual meeting, I focus on Medicare advantage plans known
as Medicare Parts see, and I cover the benefits of

(24:46):
that platform. My next two meeting dates thus far are
going to be October ninth in October fourteenth. I'll probably
have some more dates in late October and early November,
but I just don't have those dates ed. I probably
won't have those to October first. You can call our
office at five six three three three two two two

(25:08):
zero zero for additional zoom meeting codes, dates and additional times.
You're also welcome to email me at Craig at Craigshillig
dot com. And that's my name, c R. A. I
G AT c R A I G S c H
I L L I G dot com and I'd be

(25:29):
happy to send you the virtual zoom link, meeting codes
and additional meeting dates and times. This is Craig Shillig
with saved money.