Generation-Skipping Traps In Multi-Generational Life Insurance Trusts

Gallo, Jon J.
June 2002
Journal of Financial Planning;Jun2002, Vol. 15 Issue 6, p26
Academic Journal
The article discusses the efficiency of irrevocable life insurance tax in leveraging generation-skipping transfer tax exemption in the U.S. Leveraging is the process by which each dollar of exclusion or exemption allocated to a transfer insulates some multiple of itself from the generation-skipping tax system. Using the generation-skipping tax exemption in this manner offers two important advantages, namely, any appreciation in the value of the assets owned by the exempt generation-skipping trust will escape all transfer taxes when the children die and will instead pass tax-free to the grandchildren and the trust may be protected from the claims of creditors and, to some degree, from claims of ex-spouses. For an insurance trust to function as a generation-skipping trust, the trust must be drafted to avoid creating general powers of appointment in the beneficiaries, which would subject the trust corpus to estate taxation at their deaths. But a paradox exists because the most common method of funding an insurance trust is to grant the beneficiaries a Crummey withdrawal right. A Crummey withdrawal power is a general power of appointment over the property subject to withdrawal. Even if a generation-skipping transfer tax exemption is allocated to all transfers to an insurance trust, the lapse of the beneficiaries' withdrawal powers may subject the trust to federal estate tax when the beneficiary passes away. The possibility of a taxable release of a Crummey right must be avoided at all costs when drafting a generation-skipping life insurance trust. At least two strategies are commonly employed to avoid taxable releases. First, the Crummey right may be limited to the five-and-five safe harbor, with the applicable exclusion amount being used to the extent that the transfer exceeds the greater of five percent of trust corpus, or $5,000. Second, the Crummey right can be structured as a hanging power.


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