Author: Michele Braverman

Americans pay hundreds of billions of dollars in life insurance premiums per year. Most policyholders will never see a payout themselves. Instead, it will go to their loved ones to provide for them when the policyholder dies. 

Life insurance benefits and claims totaled $797.7 billion in 2022, including more than $88 billion in death benefits, according to the Insurance Information Institute. The typical life insurance payout is approximately $168,000. 

If a policyholder designates a beneficiary on their life insurance policy, the death benefits are not typically part of a decedent’s estate that goes through the probate process because they pass directly to beneficiaries. However, the potentially large cash value it can provide makes it central to estate planning and requires careful consideration about how to structure the beneficiary designation. 

Naming a Spouse or Children as Beneficiaries

The most common beneficiaries of a life insurance death benefit are a surviving spouse and/or children. 

Life insurance death benefits are typically protected from creditor claims for policyholders’ debts. But once the designated beneficiary receives the death benefits, the beneficiary’s creditors can go after the funds to satisfy the beneficiary’s debts—even debts owed jointly with the deceased policyholder (for example, an outstanding loan or credit card debt where the policyholder and the spouse are co-signers). This is true whether the beneficiary is the policyholder’s spouse, child, or other loved one.  

The death benefit of the life insurance policy may also be open to claims of the named beneficiary’s spouse. If a surviving spouse beneficiary remarries or a child beneficiary divorces, for example, the death benefit proceeds received by the beneficiary and put into one of their accounts or investments could end up being categorized as marital assets and, therefore, subject to equal division in the event of a divorce. This outcome could countermand the intention of the policyholder. 

If no beneficiaries are named on an insurance policy or if the beneficiary named is the policyholder’s estate, then a probate estate will likely need to be opened to administer and transfer the death benefit to the policyholder’s heirs or beneficiaries. Once the probate estate has been opened, the deceased policyholder’s creditors may have an opportunity to claim the death benefit before the funds are distributed to the heirs or beneficiaries of the estate. 

Minor child beneficiaries present challenges as well. Insurance companies cannot pay insurance proceeds directly to minor children. An adult will usually have to be appointed to manage the funds until the child reaches the age of majority. Depending on your state, this may involve a court proceeding and annual reporting requirements that cost money and can delay the payout. 

Some life insurance policies allow a custodian to be assigned to a minor child beneficiary without needing a probate court appointment. A custodian manages the money for the minor child until they reach legal adulthood, when the assets are turned over to them. 

Naming a Charity as Beneficiary 

A life insurance policy can be a way to make a charitable gift at the end of life. This option might appeal to a client who purchased a policy to protect a spouse or children who no longer need it, to complete payment of a mortgage, tax, or other debt that is no longer a concern, or to cover some other contingency that no longer requires the funds a life insurance policy would have provided. 

A life insurance policy can also be purchased for the express purpose of charitable giving. In addition to taking out a new policy to benefit charity, a charitable recipient can be named as a beneficiary on an existing policy to receive all or part of the policy proceeds. Other options include transferring ownership of a policy to a charity and gifting dividends from a life insurance policy to a charity. 

Each of these options can provide tax benefits. Depending on how a life insurance gift is made, the cash value of the policy, the cost of premiums paid, or the value of dividends may be deducted. 

Creating a Trust for a Loved One

Naming individuals as life insurance beneficiaries can provide convenience and flexibility for beneficiaries because the money passes to them quickly and easily outside of probate. The beneficiaries only need to file a claim with the life insurance company and select how they want the death benefit to be paid (usually in periodic payments or a lump sum). 

However, there are downsides to setting up a death benefit in this way. The policyholder ultimately loses control over how the insurance proceeds are used. They may have intended to protect their loved ones financially—but if they are deceased and the funds are in the hands of their beneficiaries with no controls or restrictions, can they ensure that the benefit is used in accordance with their wishes?  

They can. Policyholders can control the death benefits of their life insurance policy by naming a trust they have set up as the policy’s beneficiary and allowing a trustee to manage the death benefit on behalf of trust beneficiaries, such as a spouse or children. This arrangement allows the client to provide instructions about how the money should be used and managed. 

A trust can be useful for leaving money to underage or special needs children. It can also ensure that a disabled beneficiary remains eligible for government assistance or keep a young adult from spending the funds all at once. Insurance proceeds held in trust are also protected from creditors and exempt from probate. 

Advising Clients on Life Insurance 

About 90 million American families rely on life insurance for financial protection and retirement security. However, recent survey data indicates that more than 100 million Americans are facing a life insurance coverage gap, presenting an opportunity for advisors to steer them toward these products. 

As a value add, advisors can explain how life insurance fits into an estate plan and walk them through the different options for naming beneficiaries. These discussions could open new revenue streams, such as establishing trusts and charitable donations. 

Please contact our team for a primer on life insurance and estate planning and how our practices can benefit each other. 

With few exceptions, almost every client should have life insurance, just as everyone should have an estate plan. 

But simply having a policy—and a plan—is not enough. Both life insurance policies and estate plans are prone to mistakes or oversights that can undermine their effectiveness. And those mistakes or oversights can be compounded when life insurance is part of a client’s estate plan. 

Mistake #1: Not Having Enough Coverage

The need for life insurance in the United States grew to a record-high level in 2024, with 102 million adults saying they need—or need more—life insurance, according to an annual survey from LIMRA and Life Happens, two nonprofit industry trade associations. 

Survey results from a prior year indicated that 44 percent of households would encounter major financial difficulty within six months if the family lost its primary wage earner. Life insurance coverage should be sufficient to sustain a household’s current living standard. Household spending varies by age group and tends to drop with age, but it does not consistently decline until after age 65. Many households see a jump in spending at around age 55. 

Life insurance calculators can roughly estimate how much coverage is needed. However, there is no substitute for a comprehensive review of a client’s situation, insurance needs, and estate planning goals by all the client’s trusted advisors. By collaborating, we can make sure that our mutual clients are getting the coverage they need to meet their unique situations and goals.

Mistake #2: Relying on Employer or Group Insurance

While group life insurance offered through work or a professional organization is often cheaper than an individual policy, it may not provide enough coverage for most families. There is also the risk that the policyholder will lose their policy if they quit their job, retire, are fired, or sever ties with the sponsoring organization. 

Clients should be encouraged to take advantage of a group insurance policy if offered but cautioned not to rely on it exclusively. As part of your discussion with the clients, consider asking them about the maximum death benefit of their group policy so you can determine the coverage gap amount. 

Mistake #3: Not Listing a Beneficiary

Life insurance policies with a designated beneficiary are not governed by a client’s will (unless the beneficiary is the policyholder’s estate). It is up to the clients to name a policy beneficiary (or beneficiaries) to whom they want to receive the death benefit. 

If an individual policyholder does not name a beneficiary, the death benefit proceeds could become part of the policyholder’s estate—possibly subjecting the beneficiary to the delays and expenses of probate court. 

For group insurance policies with no named beneficiaries, the terms of the policy may include an automatic beneficiary order, such as the policyholder’s spouse, followed by children, parents, and the estate. Not naming a beneficiary and relying on the terms of the life insurance policy could result in the proceeds being distributed to the predetermined beneficiaries, which may not be in line with the policyholder’s estate planning goals. This is also true if the death benefits fall to the policyholder’s estate and the policyholder dies without a will. If the policyholder had a will or a trust, the distribution of death benefits from the estate follows the plan established in their estate plan. 

As a practical note, we advise all clients to inform the people they designate as beneficiaries of their life insurance policies and, ideally, give them contact information for the claims department of the plan provider. Life insurance proceeds sometimes go unclaimed because the family has no idea a policy exists. 

Mistake #4: Naming a Minor Child or Special Needs Beneficiary

Life insurance death benefits can be a lifeline for minor children and special needs beneficiaries. However, naming a minor or disabled beneficiary can work counter to the goal of providing them with financial security. 

Life insurance companies cannot pay death benefits directly to minor children. To avoid any legal complications and delays that can arise from this obstacle, a client can name a trust with a trusted adult, such as a spouse or partner, to act as the trustee of the trust, to manage the death benefit for the child according to the client’s wishes. The court may have to get involved if the client names a minor child as a beneficiary. 

Two main issues with naming a disabled or special needs beneficiary on a life insurance policy are that they may not have the capacity to manage the funds responsibly, and the death benefit amount could disqualify them from means-tested government assistance programs. A third-party special needs trust can be created to hold insurance death benefits for those with disabilities. This type of trust will help the special needs beneficiary retain their public assistance eligibility while covering expenses not covered by programs like Medicaid or Social Security. 

Mistake #5: Not Updating Beneficiaries

Out-of-date beneficiary designations are a common—and potentially costly—life insurance mistake. 

Clients should update beneficiaries anytime there is a major life event, such as a marriage, divorce, birth, or death. Remind them that the insurance beneficiary forms take precedence over their will. 

Some states have “revocation upon divorce” statutes that automatically revoke a spouse as a beneficiary in the event of a divorce. In such states, contingent or successor beneficiaries become primary beneficiaries automatically without the policyholder needing to update their beneficiary form. But if the policy does not name a contingent beneficiary—or the successor beneficiary has predeceased the policyholder—the insurance proceeds could pass to the estate and go through probate, subjecting the proceeds to unnecessary and sometimes substantial costs. 

Both primary and secondary beneficiary designations should be reviewed every three to five years to ensure a death benefit goes to the right person. Absent a major life event, the client could just change their mind, for personal reasons, about who should benefit from the policy. They might also decide to switch the beneficiary from an individual to a charity or a trust. Also, there are times when insurance plan providers are bought by or merged with new plan providers or when an employer may change the company that provides their group plan life insurance policy. In these situations, the original beneficiary designations may be wiped out, requiring the policyholder to designate their beneficiaries anew.

Changing a beneficiary designation is usually a simple process. Still, community property states may require the policyholder to name their spouse as the primary beneficiary, designated to receive at least 50 percent of the benefit. In these states, written spousal consent may be required to name somebody other than the spouse as a beneficiary. 

Enhance Your Advisory Services with Estate Planning 

Our job as advisors is to remind clients that planning is not a one-time event. It is a continual process that needs to be revisited and refined over the years. 

It is no different for our practice area. The more we learn from each other, the more we can offer cross-disciplinary services that address all aspects of our clients’ futures. 

Please contact us to set up a time to discuss specific estate planning strategies and how they can fit into your current offerings. 

Optimize Generational Wealth Transfers with These Insights 

Generation-Skipping Transfer Tax 101 

Many of you are likely familiar with estate and gift taxes. However, dealing with the generation-skipping transfer (GST) tax comes up less often since it usually only affects ultra-wealthy clients.   

Estate planning attorneys, financial planners, and tax advisors must understand the GST tax and learn how to avoid it to help affluent clients accomplish effective planning. Explaining the GST tax to clients is easier if you share examples of how it might impact their particular situation. It is also vital to consider unique family dynamics, financial goals, and values when recommending the best tax strategies to distribute generational wealth. 

What Is Generation-Skipping Transfer Tax? 

The government collects federal estate taxes to generate revenue when wealth is passed down to subsequent generations. When people die, they usually leave their money first to their spouses, then to their children, then to their grandchildren, and then to more distant relatives. At each passing of generational wealth, the government collects an estate tax.  

Wealthy families found a way to avoid estate tax by skipping a generation and transferring wealth directly to grandchildren and great-grandchildren, allowing them to pass down more wealth to future generations. Estate taxes were avoided when the skipped generation (in our example, the children) died because the children never owned the money or property.  

The government responded with legislation in 1976 and again in 1986, attempting to eliminate the transfer tax advantage of skipping a generation by imposing a GST tax when a skip occurs, ensuring that large estates still pay estate tax at each generation.   

The GST tax rate is currently 40 percent (the same as the highest federal estate and gift tax rate) so the tax burden on high-net-worth individuals can be substantial. Luckily, there is a GST exemption amount of $13.6 million for individuals in 2024 (the same as the federal estate and gift tax exemption) that can be used when clients want to make gifts or leave an inheritance that would otherwise be subject to the GST tax. This means that only large estates are truly impacted by the GST tax. 

Who Are the Parties Involved in a Generation-Skipping Wealth Transfer? 

There are typically three parties involved in a generation-skipping wealth transfer: 

• The transferor: the person making the wealth transfer to an individual or a trust  
• The skip person: the person receiving the money or property, who must be two or more generations removed from the individual making the transfer or is at least 37 ½ years younger than the transferor; a skip person may also be a trust in some instances 
• The non-skip person or the skipped person: the generation between the individual transferring wealth and the one receiving it 

Why Should Clients Be Mindful of This Tax? 

Clients with substantial estates who are considering making sizable gifts or bequests to skip persons need to work with experienced professionals so they understand the tax consequences of these gifts or bequests, and so they can develop a strategy to properly utilize their GST tax exemption. 

The earlier you can get your client started, the better the results. It will take time and collaboration with other professionals to ensure the best possible outcome. Additionally, as with any type of estate planning, you will need to remind the client about regular reviews for updates to their plan due to changing circumstances. 

Partnering with Professionals to Align Legal and Tax Planning Strategies 

Working together, we can provide our clients with comprehensive advice, ensuring that legal, financial, and tax implications are all considered in their estate planning strategies. This will enhance the overall quality of the service and expertise your clients receive. We welcome the opportunity to partner with you to develop strategies to assist our mutual clients.

The generation-skipping transfer (GST) tax, is a tax assessed on gifts from one person to another person in two or more generations younger, or someone who is at least 37 ½ years younger (also known as a skip person). Although not everyone will have to address this as part of their estate plan, if you have clients who are looking to make a large gift or leave a large inheritance to a skip person, it may be beneficial to see how the math works in this type of situation.

Generation-Skipping Transfer Tax Rate  

The federal GST tax rate matches the highest federal estate tax rate, currently set at 40 percent. For high-net-worth individuals, effective GST tax planning is crucial in managing combined estate, gift, and GST tax burdens. 

Generation-Skipping Transfer Tax Exemption  

Individuals can transfer a specific value of money and property to skip persons, either during their lifetime or after death, before triggering the GST tax. This exemption equals the federal estate and gift tax exemption amount ($13.61 million in 2024). Be aware, there is no portability for the GST tax exemption. Therefore, clients need to use it or they lose it.   

Exceptions to the Generation-Skipping Transfer Tax  

Your client may already have a trust. If so, certain irrevocable trusts established before September 25, 1985, are grandfathered and exempt from the GST tax provisions in section 26.2601-1(b)(1) of the Treasury Regulations. Modifications or additions to these trusts can jeopardize the exception. Additionally, gifts for educational or medical expenses to skip persons, such as health and education exclusion trusts (HEET), are excluded from GST tax application. 

Applicable Fractions and Inclusion Ratios 

To understand how the GST tax will affect your client’s estate, you need to do some math. The GST tax calculation relies on the inclusion ratio, indicating the extent to which a transfer is subject to GST tax. This ratio is determined by the applicable fraction, considering the individual’s GST tax exemption. An inclusion ratio of one means the direct skip or trust is fully taxable. Any number between zero and one indicates the transfer is partially subject to GST tax.  

The amount of the GST tax exemption allocated to the transfer is divided by the value of the property involved in the transfer. The fraction is rounded to the nearest one-thousandth (.001) and looks like this:  

The next step is determining the inclusion ratio by subtracting the fraction from the number one. Depending on the ratio, the trust is either fully exempt, fully taxable, or partially taxable.  

Fully Exempt Trust 

Let’s say your client creates an irrevocable trust for the benefit of a grandchild and their descendants in 2024, when the entire GST tax exemption of $13,610,000 is available and allocated to the trust.  

If your client transfers $13,610,000 (or less) to the trust, the inclusion ratio would be zero: 

1 – (13,610,000 / 13,610,000) = 1 – 1.000 = 0 

The trust would be fully exempt from GST tax. 

Fully Taxable Trust 

Now, let’s assume that your client had previously used their GST tax exemption and there was none available to allocate to the grandchild’s irrevocable trust, the inclusion ratio for this transfer would be one: 

1 – (0 / 13,610,000) = 1 – 0 = 1 

The trust would be fully subject to GST tax. 

Partially Exempt Trust 

Partially exempt trusts have a portion of money or property subject to the GST tax, while another portion may qualify for an exemption.    

If your client puts $15,500,000 in the irrevocable trust, and their entire exemption is available, the inclusion ratio would be: 

1 – (13,610,000 / 15,500,000) = 1 – .878 = .122  

The applicable fraction is .878, and the inclusion ratio is .122. The trust would be partially subject to GST tax. When distributions are made to the grandchild, there will be a tax due. To calculate how much will be owed, we first must know what the tax rate is at the time of the distribution. For example, if the rate is 40 percent, 

40 percent x .122 = 4.88 percent

If the grandchild receives a taxable distribution from the trust of $125,000, the GST tax would be $6,100.

For gifts or bequests made directly to the skip person, the formula works similarly, the inclusion ratio is multiplied by the GST tax rate in effect at the time of the transfer.

It Takes a Team 

We understand that the GST tax can be complicated at times. By working as a team, we can assist our clients in planning and carrying out their wishes.

If you have clients with significant wealth, things like estate, gift, and generation-skipping transfer (GST) taxes need to be discussed. If a client wishes to make a gift or leave a large inheritance to a grandchild (while their child is still alive) a more in-depth conversation surrounding the GST tax needs to be addressed. As an advisor, it can be helpful if you understand the basics of the GST tax, the impact it can have on a client’s estate plan, and additional steps that may occur during the administration process at the client’s death.    

Several different returns involve the GST tax and we will touch on a few of them in this article. The appropriate form that needs to be filed with the Internal Revenue Service (IRS) will depend on the situation.

What Is Form 709?

This form would be used when a client decides to make a gift to a skip person during their lifetime. Form 709 is used to report transfers that are subject to federal gift and certain GST taxes. This also includes the allocation of lifetime GST exemption to property transferred during the transferor’s lifetime. The IRS has provided instructions for the transferor to complete the form.

What Is Form 706-GS(D-1)?

Form 706-GS(D-1) is used for trustees of a trust to report distributions from a trust to a beneficiary that are subject to the GST tax. For additional assistance, the IRS has published instructions for completing the form.

What Is Form 706-GS(D)?

Form 706-GS(D) is used for skipped persons to report tax due on distributions made from a trust to them, that is subject to the GST tax. Like the other forms from the IRS, some instructions walk through the completion of the form.

What Is Form 706-GS(T)?  

Form 706-GS(T) is used for trustees and any other entities or responsible parties to calculate taxes and report what is due from certain distributions and trust terminations subject to the generation-skipping tax. There are instructions for tax computation and separate sections for required information for the transferor and the trust.   

You can help affluent clients create a detailed list of documents and information required to determine the value of the money and property transferred to their trust or given outright as a gift or part of an inheritance. Understanding the complex calculations is critical.  

The amount of the GST tax exemption allocated to the transfer is divided by the value of the property involved in the transfer. The fraction is rounded to the nearest one-thousandth (.001) and looks like this:  

The next step is determining the inclusion ratio by subtracting the fraction from the number one. Depending on the ratio, the trust is either fully exempt, fully taxable, or partially taxable. 

Completing the Forms 

To fill out the applicable forms, individuals need to gather a significant amount of information. Here is a list of some of the information that may be needed: 

• The legal name of the trust and its federal tax identification number 
• Name and Social Security Number (SSN) or Employer Identification Number (EIN) of theindividual making the GST 
• A list of all beneficiaries, including their names and relationships to the transferor 
• The generation of each beneficiary in relation to the transferor (skip person or non-skip person) 
• Name and address of the trustee(s) responsible for managing the trust 
• A detailed list of all assets held within the trust, including values at the time of the GST 
• Appraisals of assets to determine their fair market values 
• Information about any other gifts or transfers made by the transferor during their lifetime that could be subject to the GST tax 
• Indication of how the transferor’s GST tax exemption will be allocated among the trusts 
• Allocations to skip persons, including any direct skips, indirect skips, or taxable terminations 
• Details aboutthe transferor or any beneficiary who is deceased 
• Copies of the trust agreement and any amendments 
• Any legal documents relevant to the GST 
• Specific dates of GSTs 

Filing Deadlines 

Generally, these forms must be filed by April 15 of the year following the calendar year when the gift, distribution, or termination occurred. Help your client organize and prepare their information. Maintaining clear records and staying informed about any updates to tax laws will streamline the process of completing the filing on time.   

Collaborative Opportunities 

Working with other professionals outside of your area of expertise can help ensure accuracy and compliance with the GST tax rules. When we work together, we can provide the best possible service to our clients. Give us a call to learn more about ways we can collaborate.