As people age into their 80s with longer life expectancies, their mental capacity is often diminished when it comes to managing their financial affairs. This declining capacity suggests an interesting issue which can impact whether continued gifting of premiums to Irrevocable Life Insurance Trusts (ILITs) can take place.
Many ILITs have been funded with no-lapse Universal Life (UL) and no-lapse Survivorship Universal Life (SUL) since the late 1990s. In a typical design, the account cash value falls to $0 by the time insureds reach their 80s. If the insured estate owner develops a reduced mental capacity such as Alzheimer’s, they may be unable to manage their financial affairs. It would be easy to miss premium payments into a no-lapse UL or SUL type of product which may cause the policy to quickly lapse for non-payment.
How can your client take the necessary steps to make sure this unfortunate scenario does not take place?
A Durable Power of Attorney document is a critical piece of a good estate plan for wealthy clients who have ILITs they are depending upon to offset federal estate taxes, state death taxes, and other final expenses. This legal document allows the power holder (attorney in fact) to execute specific legal and financial transactions on behalf of the incapacitated person. It may be crucial to a wealthy individual’s estate plan that a planned giving program be continued all the way until the death of the estate owner. This is of importance if continued premium gifts to an ILIT must be made to keep the policy in force all the way until death. The durable power holder would have to make premium gifts on behalf of the incapacitated estate owner. Therefore, it is critical that the power holder have clear and specific authority in the durable power document to make these gift transfers.
Several Tax Court cases and IRS Rulings have held that a Durable Power of Attorney document must contain specific clauses which allow the power holder (attorney in fact) to make gifts of the incapacitated person’s property for purposes of the gift tax annual exclusion, the lifetime gift exemption, or the generation skipping exemption. If the document is silent with respect to this gifting power, then the power holder is presumed NOT to have the power to make gifts. This lack of power could cause a no-lapse UL or SUL type of policy to lapse quickly for non-payment of required annual premium.
A number of U.S. Tax Court cases basically have taken the position that, in the absence of state law to the contrary, the power holder does NOT have the authority to make gifts of the incapacitated person’s property where that authority is not expressly conferred in the document. Most states also support this view with state statutory laws.
In addition to the power to make gifts, a good Durable Power of Attorney document can allow the power holder to perform several other important legal and financial functions:
- The estate owner must have sufficient mental capacity to execute the Durable Power document in the first place. This mental capacity is much the same as whether a person has the mental capacity to execute a will.
- The power to acquire life insurance on the lives of family members of the grantor of the Durable Power in whom the grantor has an insurable interest
- The power to retain any investments and to change and vary the form of any investments owned by the estate owner
- The power to invest in fixed and variable annuities and stocks, bonds and mutual funds as the power holder deems advisable including cash and money market accounts
- The power to sell, exchange or convey any property owned by the grantor of the Durable Power
- The power to manage, operate, mortgage and lease any real estate of the grantor
- The power to continue and to operate any business entity where the grantor owns shares in that entity
- The power to compromise and settle any legal claim due to the grantor or against the grantor
- The power to borrow money for any purpose connected with the protection, preservation and improvement of the grantor’s assets
- The power to employ agents such as attorneys, accountants, investment professionals and real estate brokers whose services may be required to administer the assets of the grantor
- The power to make gifts or gratuitous transfers to a spouse, descendants or charitable organizations. The maximum gift permitted each year to a non-charitable donee shall normally be limited to the maximum gift tax annual exclusion permitted under IRC Section 2503(b) and the unlimited educational and medical expense gifts permitted under IRC Section 2503(e). However, for estate planning purposes the power holder may make additional gifts up to an amount equal to any remaining lifetime gift exemption as permitted by IRC Section 2505(a), as amended from time to time.
- The grantor should also designate a successor power holder in case the original power holder dies, resigns or becomes incapacitated themselves.
Case example of no-lapse SUL policy owned by an ILIT:
Mr. and Mrs. Jones created an ILIT for the benefit of their three children to be the owner and beneficiary of a $1,700,000 no-lapse guaranteed SUL policy fourteen years ago when they were each 72 years old. They also executed a Durable Power of Attorney document which permits their power holder daughter to make gifts on their behalf. They have gifted the guaranteed annual premium of $39,000 each year to the trust using their “Crummey” power gift tax annual exclusions. A cumulative total of $546,000 has already been gifted to the ILIT for premiums. The nominal account cash value of the policy has fallen to $0. Mr. Jones died three years ago and Mrs. Jones (now age 86) has recently been placed into an extended care facility and requires her Durable Power holder daughter to manage her financial affairs.
It is critical that the power holder daughter continue to make the $39,000 annual premium gifts to the ILIT to keep the $1,700,000 no-lapse SUL policy in force. If the policy ever lapsed for non-payment of premium because the cash gifts were not made to the ILIT, the valuable income and estate tax free benefit of $1,700,000 would be lost to the heirs.
BSMG Advanced Sales can provide a specimen Durable Power of Attorney document that includes the power to make annual gift exclusion and lifetime exemption gifts. This gifting power is extremely important. It will permit the power holder (attorney in fact) to make sure that valuable policies owned by ILITs stay in force to provide an income and estate tax free death benefit.
Russell E. Towers JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group