Situation: The uncertainty of the estate tax laws has created a dilemma for many taxpayers, estate planners, and insurance professionals. Should moderately high net worth couples take action today to shelter a significant amount from estate tax (under the $11.7 million exemption) by making a large gift; or should they hold off making a large gift and hope that the value of their estate stays under what is likely to be a much smaller exemption in the future?
One of the most obvious examples of this dilemma is found with the traditional irrevocable life insurance trust (“ILIT”), which has played a critical role in estate planning for many years. If an ILIT is established, access is significantly limited. On the other hand, if a decision is made to wait to establish an ILIT, the proposed insured’s health could deteriorate, thus significantly increasing the cost of insurance coverage. Even worse, the individual may become uninsurable and insurance may be unavailable especially in this COVID environment.
The Standby Trust (also referred to as the Wait-and-See Trust) was developed as an alternative to the ILIT because it permits the insureds (i) to purchase survivorship life insurance today based upon current underwriting conditions and (ii) to retain a great deal of flexibility. This Counselor’s Corner provides information about this arrangement.
Solution: In general terms, the Standby Trust arrangement utilizes an ownership and beneficiary structure on a survivorship policy on the lives of a married couple. The insured with the shorter life expectancy is named the initial owner of the life insurance policy (“the insured owner”) and premium payer. At the time the insurance is purchased, a trust (i.e., the Standby Trust) is also established as either an existing stand-alone (revocable or irrevocable) trust or as a testamentary trust and is named the contingent owner and primary beneficiary. If the estate tax continues to not apply to the client’s situation, the Standby Trust may not be utilized. On the other hand, if the estate tax does apply, then the life insurance policy can be transferred to the Standby Trust in an attempt to minimize future estate tax consequences.
Under this arrangement, trust ownership of the policy is normally deferred until after the death of the first insured, thus giving the insureds the time needed to make any irrevocable decisions concerning the ultimate policy ownership. Consequently, during the lifetime of both insureds, this arrangement provides the insured owner of the policy with (i) a great deal of flexibility, (ii) easy access to cash values for retirement and other uses, and (iii) the potential to exclude the net death benefit from the estate of both insureds. It is important to note, however, that there is a price associated with all of the flexibility. In a Standby Trust arrangement, since the insured owner initially owns the policy, the entire cash value will be included in his/her taxable estate if he/she is the first to die. The application of the so-called “three-year rule” of IRC Section 2035 is also a possibility.
 Since this technique does not require ownership of the survivorship policy by the Standby Trust from the inception, it is not necessary to have the Standby Trust in existence at the time of policy application. However, it is prudent to have the trust established as soon as possible.