Generally speaking, you would not want to put life insurance in a family partnership. This is because, in most cases, the irrevocable life insurance trust (sometimes referred to as a “Crummey trust” in reference to the beneficiaries’ power to withdraw additions that usually appear in such a trust) is already an excellent estate planning tool.
If a family partnership owns the insurance, the decedent’s estate would be increased by the pro-rata ownership interest in such proceeds. Correctly set up, the insured will have no incidents of ownership in the irrevocable life insurance trust. This feature results in the life insurance not being subject to federal estate taxes at the insured’s death.
Insurance is different from other assets in that the insured generally doesn’t plan to spend the proceeds of a life insurance policy. Still, the owner of assets certainly considers the possibility of the expenditure of those assets. This is why the irrevocable trust works well with life insurance and is far less common with other assets.
It is central to the rationale of family partnerships that the donor retains control over assets, which is less critical with life insurance. Control However, there are some instances where control over the life insurance policy might matter.
For instance, if the policy has or is expected to have a significant cash surrender value, the insured may want some access to that policy. In such a case, a family partnership should be considered. However, the insured still must be sure that there is no incident of ownership problem. This is done one of two ways:
Alternative #1: The insured is a minority or non-managing partner, so that by not controlling the partnership, the insured will not be considered controlling the policy. In such a case, the insured spouse can be in control to hope that the spouse will be acting in concert with the insured. There is nothing wrong with this, except that it still doesn’t present an advantage over using an irrevocable life insurance trust with the same spouse as trustee.
Alternative #2: There is a split-dollar arrangement under which the family partnership is the owner of the cash value, and an irrevocable trust is the owner of the death benefits. Additionally, the irrevocable trust would retain all incidents of ownership over all policy rights other than the family partnership’s right to the cash value. Your clients may likely balk at having two separate entities involved in owning a life insurance policy.
However, it may make sense in some circumstances, mainly when there is a substantial cash surrender value. The split-dollar arrangement also helps lessen (although often not eliminate) the gift tax consequence of any premiums in excess of the annual exclusion.
SPECIAL TRUST PROVISIONS
Whether an irrevocable trust is used as the partner of a family partnership, as the split-dollar co-owner of life insurance, or used by itself in estate planning, the donor-grantor will generally want to retain as much control as possible. This can run into income tax problems with the grantor trust rules and estate tax problems with Section 2036.
However, there are indirect ways to give the grantor some control. Protector One method is to use the so-called “protector.” The protector of a trust is a maverick concept and can be used very effectively.
Special Planning Strategies, a trust instrument as someone with the power to override the trustee—in some cases even replace the trustee—in extreme cases where it is warranted. The trust protector is more often thought of concerning foreign trusts, where there may be specific statutory authorization. However, domestic trusts often have these provisions as well. Sometimes it’s a matter of custom in a community whether trust protectors are used or an individual firm’s practice.
There are no exact rules as to what a trust protector can do. It’s a matter of what is written in the trust agreement. In some cases, the protector’s powers are stated in the negative rather than the positive. That is, the protector has certain veto powers. This might include, for instance, the ability to veto discretionary distributions or investments. To enforce this, the trust instrument might even state that trust accounts require two signatures, one of the trustees and one of the protector.
The protector is often limited to this negative function where the protector is also the grantor, as to do otherwise would trigger both creditor and estate tax problems. Some foreign jurisdictions, such as Belize, will permit a grantor to be a protector without jeopardizing the asset protection features of the trust.
Despite the liberal nature of a statute such as this, in most cases, the protector will have only a veto power where the protector is the same as the grantor. The protector is independent of the grantor. However, the protector may have a much more comprehensive range of powers, including replacing the trustee.
For this reason, the protector is in some cases a kind of “super trustee,” with more power than the actual trustee. If you’re using this kind of protector, make sure there are no impediments under local law to a non-trustee having this kind of power. Also, make sure there is no estate tax problem created for the protector by the extent of the powers granted.
