By: Randall A. Denha, J.D., LL.M.
A Survivorship Standby Trust (“SST”) is a very unique and powerful Estate Tax Strategy that employs a special life insurance contract along with the SST and should be considered by those wishing to maintain both flexibility and access to the cash values of a life insurance contract. This technique is a true wait and see plan because the owner controls the cash value and the policy death benefit all the way up until death. As earlier stated, it uses a special type of cash value life insurance contract, commonly known as Survivorship Life Insurance or Second to Die Policy. As the name of the particular insurance implies, the death benefit pays out at the time of death of the second insured. This type of policy works extremely well in estate tax planning for couples because there is no estate tax due until the surviving spouses death. The SST is a strategy for the personal ownership of a life insurance policy that can provide both retirement and estate planning benefits.
Unlike an Irrevocable Life Insurance Trust (“ILIT”) which requires the actual life insurance policy to be owned by the ILIT and name the ILIT as the beneficiary of the life insurance policy, the SST allows for a degree of control over the life insurance policy and its cash value which is not possible with an ILIT, while at the same time potentially sheltering the policy proceeds from estate taxation.
Generally, when establishing an SST the spouse with the shorter life expectancy purchases and funds a survivorship life insurance policy with a face amount large enough to cover the anticipated estate tax. The cash value of this policy is available for the owner to use while he or she is alive. The flexibility of this technique is this: a separately maintained stand-along trust, or ILIT, can be named as the contingent owner and primary beneficiary of this insurance policy or a specially designed trust within your estate plan can be named as the successor owner. Keep in mind that the SST is similar to an ILIT, except it does not begin to operate until the policyowner’s death. As such, the standby trust does not need to be in existence from the inception.
Upon the death of the owner of the policy, the net cash value will be included in his or her estate and the policy ownership is then transferred to the SST which Trust immediately becomes the new owner of the Survivorship Life Insurance Policy and its cash value, thus removing it from the taxable estate of the owner of the insurance policy and functions just like an ILIT. The Trustee of the Trust can then use the cash value of the policy to provide for the surviving spouse.
However, if the non-owner insured dies first, the policy owner can continue to own the policy outright, or transfer it to an ILIT. The transfer of the policy will be a gift, potentially subject to gift tax.
Upon the death of the surviving spouse the policy pays out the death benefit both income & estate tax free to the Trust. The Trust now has the cash to pay any estate taxes that may be due after both spouses have passed away.
The benefits of this technique include:
• Control over the policy and trust during the policyowner’s lifetime;
• Access to the policy values to help supplement income;
• Potential avoidance of gift taxes during the owner’s lifetime;
• Estate tax-free death proceeds for estate liquidity;
• Flexibility to revise or terminate the arrangement during the lifetime of both insureds.
Flexibility has always been an important element of an estate plan. The Survivorship Standby Trust technique can provide flexibility while fulfilling the seemingly conflicting objectives of lifetime access to policy cash value and exclusion of death benefits from the taxable estate.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.