This is the third in a series of letters designed to assist clients in understanding and planning around the Federal estate tax. In our first letter (Fall 1988) our fictional Mr. and Mrs. Abercrombie revised their Wills to lessen the impact of estate taxes, saving their family some $200,000 in the process. In our second letter (Spring 1989), the Abercrombies formed a trust to make annual tax-saving gifts to their children. Over a period of years, they created additional tax savings in excess of $300,000 by use of the trust. Call us if you would like additional copies of the earlier letters.

In this episode, the Abercrombies make another simple but smart move to save taxes. In short, they transfer their life insurance to the trust and get it out of their taxable estate.

Mr. Abercrombie has a $200,000 insurance policy on his life, purchased many years ago. Mrs. Abercrombie is the beneficiary of this policy. The Abercrombies are now well-to-do enough that Mrs. Abercrombie would not really need the proceeds of the policy to maintain her standard of living. In addition, if it were paid to her, it would end up in her estate and be taxed at about a 50% rate (i.e., about $100,000 of the $200,000 would go to the IRS).

So what can the Abercrombies do? They can transfer the policy to the trust for the benefit of their children, at no tax cost. The proceeds of the policy will escape estate taxation altogether, assuming Mr. Abercrombie lives for three years after the transfer.

There are variations on this strategy. For instance, the Abercrombies might be concerned about the requirement that Mr. Abercrombie live an additional three years. If so, they may encourage the trust to buy a new policy, rather than transferring the already-existing policy. If done properly, this would avoid the three-year rule.

Another variation lies in the types of insurance available. If the trust is buying new insurance, it may be advisable to buy "survivorship" insurance, payable only when both Mr. and Mrs. Abercrombie have died. This insurance is considerably less expensive and may actually be payable at a more appropriate time: it is likely funds will be needed to pay estate taxes only after both spouses have died.

To sum up, there is great opportunity to save estate taxes through the proper handling of life insurance. If you suspect a bit of planning might pay off for you, please call the attorney with whom you work, or Alan Macpherson, Larry Ghilarducci, Al Falk or Eileen Peterson of our Tacoma office.