B Trust Leveraging
WHAT IS A B TRUST?
A B Trust is a trust created via the will of
a testator. The maximum amount that can be used to fund the B Trust
is the amount of the estate exempt from federal estate taxes regardless
of the nature of the beneficiary. Under current tax law that amount
is $2,000,000 for the years 2006 through 2008.1 This
amount will then rise to $3,500,000 in 2009, and become unlimited
in 2010. However, under the current tax structure, this amount will
drop to $1,000,000 in 2011 and beyond when the estate tax is re-established.
WHAT DOES THE USE OF A B TRUST ACCOMPLISH?
B Trust leveraging is a way to maximize the effectiveness
of the exempt amount in the client's estate. The testator includes
a clause in his or her will which states that the estate is to be
placed into two trusts, the A Trust, or Marital Trust, and the B
Trust. The executor funds the B Trust first by placing in the B
Trust sufficient assets to use the full amount of the exemption,
that is, $2,000,000 for 2006. The executor funds the A Trust with
the remaining estate assets.
The monies used to fund the B Trust are not subject
to estate tax.
2 The B Trust
itself is not subject to estate tax in the estate of the surviving
spouse because he/she has no power to demand or control these assets,
although the trustee may have the power to distribute assets to
him/her in time of need. Therefore, under current tax law, the funds
in the B Trust can continue to grow without any estate tax consequences
to the estate of either spouse.3
WHAT ARE THE DISADVANTAGES OF A B TRUST?
Two (2) realities
face the trustees of B Trusts. First, the income tax rates applicable
to B Trusts are high and begin when the trust has earned a modest
amount of income.4 Second, the B Trust assets may be
needed for the health, maintenance, education, and support of the
surviving spouse. Therefore, many trustees of such trusts invest
in municipal bonds or fixed income assets which may have limited
growth potential as a means to protect the trust from taxation and
erosion of value.
HOW DO YOU MITIGATE THE DISADVANTAGES
OF A B TRUST?
The best way to mitigate the disadvantages of
the B Trust may be to leverage the trust assets through the purchase
of a life insurance policy on the surviving spouse. By buying a
life insurance policy on the surviving spouse the trustee can obtain,
based on the life insurance product purchased, an attractive rate
of return that may not be matched by fixed income assets. Purchasing
the policy within the B Trust structure also eliminates the income
tax problem of the B Trust. The inside build up of the life insurance
policy is not subject to current federal or state income tax. There
are also no gift tax consequences to buying the life insurance policy
within the B Trust.
" The best way to mitigate the disadvantages
of the B Trust may be to leverage the trust assets through the purchase
of a life insurance policy on the surviving spouse. By buying a
life insurance policy on the surviving spouse the trustee can obtain,
based on the life insurance product purchased, an attractive rate
of return that may not be matched by fixed income assets. Purchasing
the policy within the B Trust structure also eliminates the income
tax problem of the B Trust. "
ARE THERE ANY SPECIAL CONSIDERATIONS
IN LEVERAGING B TRUST ASSETS?
One major consideration is that the surviving
spouse must not need the income from the B Trust assets that will
be used to purchase the life insurance policy. Remember another
major consideration is that using the B Trust assets to purchase
a single premium policy will result in that policy being a Modified
Endowment Contract or "MEC." A MEC can have negative tax consequences.
When a life insurance policy becomes a MEC, any withdrawals made
by the trustee from the cash value while the insured is alive are
subject to income tax. Indeed, if the insured is under age 59½ the
withdrawals will also be subject to an IRS penalty tax. The terms
of the trust must not prohibit the trustee from purchasing life
insurance. Note that this tax result can be avoided by not purchasing
a life insurance policy via a single payment method.
The spouse must not be the trustee of the B Trust
and should disclaim (within nine (9) months of the first spouse's
death) or release (allowed in some states) any special powers of
appointment granted to such spouse and any rights to withdraw funds
from the trust. Finally, B Trust leveraging assumes that the surviving
spouse is healthy enough to qualify for insurance.
CAN YOU GET LONG TERM CARE PROTECTION
WITH B TRUST LEVERAGING?
Some insurance carriers
offer life insurance policies with long term care ("LTC") riders
to cover the insured for LTC costs. If a trustee of a B Trust purchases
a policy with such a rider and the insured later qualifies for LTC
benefits, there is a possibility that this rider may cause the death
benefits of the policy to be included in the insured's estate. Whether
the death benefits are includible or not depends on the wording
of the trust. If the trustee can make distributions to the surviving
spouse if they need money for their health, education, maintenance
or support, and if the trustee is not obligated to use the policy
values to fund any such obligation, then there may be a position
to use the benefits of the policy rider to help the surviving spouse
without causing inclusion of the death benefits in her estate. The
law in this area is not settled, however, and anyone contemplating
leveraging a B Trust should consult his/her tax advisors before
purchasing a policy with a LTC rider.
Also, most policies with a LTC rider available
have limits as to how much LTC benefit they will offer. Often this
means that only a portion of the assets in the B Trust can be used
to buy a policy with an LTC rider. The remaining assets can be used
to buy another policy or be invested by the trustee.
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1 IRC Sec. 2001(c), 2010(c)
2 IRC Sec. 2001(c), 2010(c)
3 IRC Sec. 2001(c), 2010(c)
4 IRC Sec. 1(e)
For use with non-registered products
only. The annuity and insurance products described may be issued
by various companies and may not be available in all states. All
comments about such products are subject to the terms and conditions
of the annuity and/or insurance contract issued by the carrier.
These materials are provided for educational purposes only. West
Financial Services makes no representation regarding the suitability
of this concept or the product(s) for an individual nor is West
Financial Services providing tax or legal advice. You should consult
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