United States: Tax Advice For The Well-Heeled, Idle Rich And Vastly Over-Compensated

Rate the thrill factor of THAT advice, will you?

This ranks right up there with the stupidest thing I ever suggested. Check your wallet. Talk to an insurance salesman? Naaah. I’d rather stick my head into the mouth of a lion. Oh. And hire a lawyer, too? Suuuuuuure.

Flat out. If you're buying a life insurance policy of more than $1M, you MUST buy it through a life insurance trust. Not? You're a bonehead. (Department of Honest Admissions: the Tax Geek was a bonehead).

People keep buying life insurance. For good reasons. (Hey. I edited out the profanity there!).

Some of them are tax related. Here's the situation. When you die, you rich bourgeois lumpenproletariat you, there will be vast taxes to pay. It's inevitable. And the IRS doesn't wait around. PleaseacceptoursympathiesandwhereisthecheckNOWplease.com.

There are three ways to pay taxes:

• Dip into that vast sum of cash you have lying around in your sock drawer.
• Sell that Vermeer over there (yes, that one) and the 500,000 acre cattle ranch.
• Buy life insurance.

Some assets are easy to liquidate: stocks, bonds. Some aren’t. (cf. Vermeer/ranch reference, supra). Unfortunately, your heirs sorta like to have cash. Especially when the property taxes are due on that modest 500,000 acre spread and the roof leaks on the 48-bedroom/ 112 bath cottage you left them. So you can’t mop up all of the liquidity to pay taxes and pass along the illiquid assets. Well, you could, BUT IT WOULD BE WRONG. (Am I on tape? Testing, testing).

Well, yes, but if you bite on this one you’ll need spandex for your ego. People buy insurance to make their kids/grandkids/beyond stoopit rich via dynasty trusts. Go to www.taxgeek.com and see my skeptical take on these beasts.

Life insurance works well. It is a relatively low risk, relatively low return investment. But the money’s GOING to be there when you need it. Look at it like this: you’ve created your own sinking fund to liquidate a known future tax liability.

I know. You’re a brainiac. You've figured this out (or more likely a very persuasive life insurance salesman has figured it out for you). So you’re buying a boatload of life insurance to pay the estate taxes when you die.

Here's the sick joke of U. S. death taxation. The Internal Revenue Code, in its obtuse and medieval theologically arcane way, makes it inevitable that the very solution you've chosen to solve your tax problem DOESN'T. In fact, it ADDS to the problem. How? Because the IRS will tax the life insurance proceeds.

Why? Here’s the tax jargon: "incidents of ownership." If you have them, the insurance gets taxed. And you really do need to be a medieval theologian to know when you’ve got it. Pornography’s obvious. Tax law isn’t.

There is a simple, inexpensive solution. It involves spending money on tax lawyers. Gee, what a surprise. Here’s the bait: the tax savings can be 100X (frequently more) the cost to set it up. Here’s its name: it's an irrevocable life insurance trust.

• Irrevocable because that's what you have to do to build a firewall between the life insurance proceeds and the estate tax. Once you’ve set it up you can’t change a thing (except, of course, by hiring a tax lawyer. What a surprise).
• Life insurance because that's usually the only asset inside the trust.
• A trust because . . . well, it's such a interesting and flexible little beast. And because it's been battle-tested with the IRS over many, many years.

Here's how it works. Don't buy life insurance on yourself. In-stead, set up the trust, have the trust buy the policy, and you stick the premium dollars into it. (Do this right, and it's a tax-free gift). When you die, ummm, when the policy matures, all of the money in the trust goes to benefit . . . your spouse, your kids, your grandkids, who(m)ever. Maybe even (in a roundabout Tax Geek-ish sort of way) the IRS to pay your taxes. And NO tax on the policy payoff money.

Average skid row bum. Stony broke, so no estate tax problems. "Hah! I’ll buy a $1M life insurance policy on my-self." (Term policy, of course. A $1M term policy is the Honda Civic of insurance these days.) Panhandles away to pays the premium. Dies. He thinks he’s leaving his heirs $1M. But he’s not! More like $875,000. Uncle Sam gets a $125,000 (or so) cut. All that panhandling for naught.

Don’t be a skid row bum. Then, set up a life insurance trust to hold the policy. You toss your premium money into the trust.

Cost to set one up? Quotes vary. Lawyers will quote from $1,000 to $3,000 typically. More if really strange or huge dollar policies involved. Depends on the complexity of your situation and the lawyer’s greed. Compare that to the $130,000 tax bite Skid Row Bum’s heirs faced.

Downside? You have to be insurable. Frequently the problem is, pure and simple, that the premiums are too high to justify it. But not you. You’re healthy as a . . . as a. . . ummm, how healthy ARE you?

There are more arcane obtuse idiotic rules here than you can imagine. Even after several decades of Taxpayer vs. IRS bouts, some questions are still unanswered. But don’t let this scare you off. Get a smartypants tax lawyer and do the paperwork. You’ll be fine.

Live in California, have insurance trust, use community property money to pay the premiums? Your spouse (gasp) just may own half of the policy even if the policy is locked up inside your handy dandy life insurance trust. Remedy: some mumbo-jumbo paperwork and a tiny little checking account.

Sample number 2. Your trustee must send out letters every year to the beneficiaries. (Tax jargon: "Crummey Notices"). Don’t do this right? A giant conflagration of complexity, expense, and tax poop. Remedy (shameless plug for one of the Tax Geek’s clients): hire a bank as the trustee. It’s cheap and reliable.

This is not Estate Planning 101. This is Remedial Estate Planning. Don’t buy a $1M+ policy without a trust.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.