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Life comes with many uncertainties and ambiguities. For that reason, there’s no “one size fits all” estate planning method. It’s also likely you’ll have to modify your original plan at some point due to a major family change or development, which is why it’s important to be aware of certain estate planning tools that can help you adjust to life’s many curve balls.

Following are some of the best methods to create flexibility in your estate plan. These estate planning techniques may be worth exploring, as they each offer couples access to the cash value of their life insurance plan, while helping heirs avoid major tax penalties.

1. Private Demand Loans

This strategy, which is arranged with the help of either a single life or survivorship policy, is ideal for married couples who wish to have indirect control over the policy and its cash value throughout their lifetime. Private demand loans enable people to transfer wealth in a tax-friendly manner, while also establishing an irrevocable trust.

Breaking it down:

  • Instead of gifting, loans are made to the irrevocable life insurance trust (ILIT) to pay the required premiums
  • Trustee purchases a policy on the grantor and/or his/her spouse
  • Annual loan to the ILIT may be significantly reduced depending upon required interest rates
  • Loan grantor (you) can request loan repayment (in whole or in part) if funds are needed at any point
  • Trustee can access policy cash value to satisfy the repayment demand

Important note: Due to fluctuating rates, interest must be accounted for annually during each year the loan is outstanding.

2. Spousal Lifetime Access Trust (SLAT)

Like a private demand loan, the SLAT uses a single life or survivorship policy. This trust can be an ideal wealth transfer strategy for married couples who want to provide tax-friendly estate planning but wish to obtain the policy’s cash value as a financial buffer in case of emergencies.

A SLAT may be a particularly beneficial strategy if one spouse is likely to live considerably longer than the other, as it gives the longer-living spouse access to a trust established by a spouse who has died.

A SLAT functions like a irrevocable life insurance trust (ILIT) with one major difference: the spouse is a beneficiary as well as the children, grandchildren and/or other loved ones. The trust often designates one spouse as the grantor and the spouse with the longer life expectancy as the trustee.

Breaking it down:

  • You and/or your spouse create an ILIT that is designated to be owner/beneficiary of the life insurance policy
  • You and/or your spouse gift separate property (rather than community property) to the ILIT to meet the required premium payments on the life insurance policy
  • The ILIT trustee purchases a life insurance policy on you and/or your spouse
  • The surviving spouse may distribute assets from the trust for his or her own needs, as well as the benefit of the other heirs. Since a SLAT is also considered a ILIT, beneficiaries will additionally receive a tax-free life insurance benefit when the longer living spouse dies.
  • The ILIT funds can then be used for estate liquidity by lending money to the estate or by purchasing assets from the estate

Important note: If the trustee dies before the grantor of the trust, then the SLAT assets, including the life insurance policy are typically off limits.

3. Standby trust 

This estate planning tool is established during your lifetime, with the knowledge that at the time of your death its property will be transferred according to the directions in your will. One of the reasons it’s called a “standby trust” is because the owner creates an investment plan and the executor or manager of the trust carries out this plan, but only at the direction of the creator of the trust.

Standby trusts, which are sometimes called contingent trusts, are essentially unfunded revocable living trusts that go into effect when and if families need them.

For example, if a couple worries about being mentally or physically disabled beyond the point where they can make financial decisions, a standby trust may be be a good option as it would go into effect in the event that scenario occurs.  If the creator of the trust recovers from such a disability or illness, the standby trust can remain revocable and he or she can again assume control of its assets.

A standby trust is also a good tool to help avoid the death taxes normally associated with the dissolution of an estate, since it can be continued after the owner’s death for its beneficiaries.

Breaking it down:

  • One spouse buys either a survivorship life insurance policy or a single life policy insuring the other spouse, naming the standby trust as the contingent owner of the policy.
  • The policy owner has control, as well as access to the cash value of the policy as long as he or she is living. If the policy owner dies first, the policy is transferred to the trust and the trustee names the trust as the policy beneficiary.
  • Only the fair market value of the policy is added to the estate of the decedent; the trust pays the policy premiums until the surviving spouse dies, at which point the trust receives the policy death benefit tax-free.
  • A standby trust is flexible and the owner can alter or terminate the agreement when he or she wishes to do so. The owner can also control investments and decide when a financial professional should be involved.

Important note: A standby trust is confidential, so unlike a will, only the owner, manager and other specifically designated individuals will have access to its details.

Bottom line: If it seems confusing or daunting to try and decipher which of these options could be the best one for your family, don’t hesitate to consult a financial professional that can analyze your personal situation and suggest the best solution. Since the success of these loans often depends on how trusts are structured and later divided, you may want to also consider consulting an estate planning attorney or tax attorney.

If set up correctly, one of these flexible estate planning techniques could give you a peace of mind, while providing your loved ones with tax-free benefits.

Author Ron L. Brown, CFP®

Ron is a CERTIFIED FINANCIAL PLANNER™ and President of R.L. Brown Wealth Management. He specializes in retirement, estate, and business planning for professionals and entrepreneurs. Ron assists his clients with creating a financial plan to ensure they are able to live their ideal lifestyle during retirement and leave a strong legacy for their family. Ron has been featured in The Wall Street Journal, US News, Yahoo Finance, Investopedia, and numerous other high profile financial publications.

More posts by Ron L. Brown, CFP®
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