Wrapping Up Loose Ends with an IDGT

This week I am finishing my review of the applications of an Intentionally Defective Grantor Trust (IDGT) in an integrated financial plan. The last application on my ‘punch list’ is the use of an IDGT with life insurance in financial planning. For decades an IDGT has been used to exclude the life insurance death benefit from the grantor/insured’s taxable estate. If an IDGT were the owner of a life insurance policy on the grantor, and all of the mandated formalities were observed, the proceeds of the insurance policy are not included in the grantor’s estate.

However, the use of an IDGT as the owner of a life insurance policy has fallen out of favor as a result of the American Taxpayer Relief Act (ATRA) which was signed into law on January 2, 2013. This new law makes permanent the changes enacted by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act which was enacted in December 2010. Some of the areas of tax law affected were federal estate taxes, gift taxes and generation skipping transfer taxes.

Under the provisions of ATRA, the federal estate tax exemption, the amount which may be left to heirs free of estate tax, was raised to $5,250,000 in 2013. In my tenure this “applicable exclusion amount” has been as low as $500,000. And in previous years, a trust was necessary to remove the death benefit from an estate. An example would be, if an individual was insured for, and owned $1,000,000 of life insurance, at their death; almost half of the proceeds could be lost to estate taxes.

Now that the applicable exclusion amount has been raised to $5,250,000, most individuals do not need to fear the unintended consequence of the inclusion of a life insurance death benefit into their estate. However, an IDGT as the owner and beneficiary of a life insurance policy on the life of the grantor may bring additional benefits to an individual’s estate and their integrated financial plan.

Of the additional benefits created by an IDGT, the primary one is asset protection. An asset left in a properly drafted trust provides asset protection for the corpus and by inference the heirs of the trust. This critical and often overlooked concept will be addressed in my next post.

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