How to Transfer Wealth and Reduce Your Estate Tax With Juvenile Life Insurance

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act signed into law by President Barack Obama on December 17, 2010 created an unprecedented opportunity to transfer wealth to your loved ones and significantly reduce your future tax liability over the next two years.

Juvenile life insurance is a popular new option for tax-advantaged wealth transfer. Juvenile life insurance is a flexible financial product insuring the life of a child, providing lifetime insurance coverage and tax-deferred savings. A parent or grandparent can “gift” the annual contribution to the child via a custodial account or to a trust, utilizing the frequently overlooked annual gift tax exclusion.

Because minors generally cannot directly own an insurance policy, an adult custodian (typically a parent) is appointed to manage the policy and use the funds for the benefit of the minor child under the state’s Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) until he or she reaches the age of 18 or 21 (depending on the state).

A gift of juvenile life insurance can assure a legacy of tax-advantaged growth that can benefit multiple generations, since the future proceeds of the policy will be received tax-free by the designated beneficiaries. For 2011 and 2012, in addition to the annual $13,000 gift tax exclusion, each donor has a lifetime gift tax exemption of $5 million (up from the $1 million exemption in place for 2010). There has never been a better time to give generously to family, friends and loved ones. After 2012, the lifetime gift tax exemption reverts to $1 million with a maximum 55% gift tax rate.

Parents and grandparents who are making substantial gifts need to be aware of the generation skipping tax (GST tax). Congress established the GST tax to prevent a glaring loophole by taxing transfers to related individuals more than one generation away (e.g., grandparents to grandchildren) and to unrelated individuals more than 37.5 years younger. A GST tax is imposed even when property, such as life insurance, is left in trust for a grandchild. For example, suppose a grandparent sets up a trust that leaves income to her children for life and then the remainder to her grandchildren. The part of the trust left to the grandchildren will be subject to a GST tax. For 2011 and 2012, the GST exemption has increased from $1 million to $5 million.

The increase in the GST exemption, along with the increase in the gift tax exemption, provides affluent families an opportunity to purchase juvenile life insurance for children and grandchildren and transfer significant wealth without current taxes and avoid estate taxes from being imposed on future generations. The 2010 tax bill also raises the individual estate tax exemption to $5 million. For individuals seeking to further reduce their taxable estate and ensure responsible management of the juvenile life insurance policy, a parent or grandparent can create an irrevocable life insurance trust to own the policy and designate a trustee to manage the account for the beneficiary.

According to the non-profit Juvenile Life Insurance Foundation, when a trust or other person owns the policy, the cash value or future proceeds will not be included in the taxable estate of the deceased. Wealth advisors recommend planning now, the estate tax exemption returns to $1 million with a maximum estate tax rate of 55% after 2012.

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