Real Life Money and Credit

One of the main reasons we buy life insurance is so that when we die, our loved ones will have enough money to pay off our remaining debts and final expenses.  We also purchase life insurance to provide for our loved ones’ future living expenses, at least for a while.  That’s why it may seem unfair that life insurance proceeds can be reduced by estate taxes.  That’s right–the general rule is that life insurance proceeds are subject to federal estate tax (and, depending on your state’s laws, state estate tax as well).  This means that as much as 45% of your life insurance proceeds could be going to Uncle Sam instead of to your family as you intend.  Fortunately, proper planning can help protect your family’s financial security.

The key is ownership

Generally, all the property you own at your death is subject to federal estate tax.  The important point here is that estate tax is imposed only on property in which you have an ownership interest; so if you don’t own your life insurance, the proceeds will generally avoid this tax.  This begs the question: Who should own your life insurance instead?  For many, the answer is an irrevocable life insurance trust, or ILIT (pronounced “eye-lit”).

Tip: Generally, each of us has a lifetime estate tax exemption (currently $2 million), so only individuals with estates that exceed this exemption amount need to be concerned about planning for estate tax.

What is an ILIT?

An ILIT is a trust primarily set up to hold a life insurance policy.  The main purpose of an ILIT is to avoid federal estate tax.  If the trust is drafted and funded properly, your loved ones should receive all of your life insurance proceeds, undiminished by estate tax.

How an ILIT works

Because an ILIT is an irrevocable trust, it is considered a separate entity.  If your life insurance policy is held by the ILIT, you don’t own the policy–the trust does.

You name the ILIT as the beneficiary of your life insurance policy.  (Your family will ultimately receive the proceeds because they will be the named beneficiaries of the ILIT.)  This way, there is no danger that the proceeds will end up in your estate.  This could happen, for example, if the named beneficiary of your policy was an individual who dies, and then you die before you have a chance to name another.

Because you don’t own the policy and your estate will not be the beneficiary of the proceeds, your life insurance will escape estate taxation.

Caution: Because an ILIT must be irrevocable, once you sign the trust agreement, you can’t change your mind; you can’t end the trust or change its terms.

Creating an ILIT

Your first step is to draft and execute an ILIT agreement. Because precise drafting is essential, you should hire an experienced attorney.  Although you’ll have to pay the attorney’s fee, the potential estate tax savings should more than outweigh this cost.

Naming the trustee

The trustee is the person who is responsible for administering the trust.  You should select the trustee carefully.  Neither you nor your spouse should act as trustee, as this might result in the life insurance proceeds being drawn back into your estate. Select someone who can understand the purpose of the trust, and who is willing and able to perform the trustee’s duties.  A professional trustee, such as a bank or trust company, may be a good choice.

Funding an ILIT

An ILIT can be funded in one of two ways:

1. Transfer an existing policy–You can transfer your existing policy to the trust, but be forewarned that under federal tax rules, you’ll have to wait three years for the ILIT to be effective.  This means that if you die within three years of the transfer, the proceeds will be subject to estate tax.  Your age and health should be considered when deciding whether to take this risk.
2. Buy a new policy–To avoid the three-year rule explained above, you can have the trustee, on behalf of the trust, buy a new policy on your life.  You can’t make this purchase yourself; you must transfer money to the trust and let the trustee pay the initial premium.  Then, as future annual premiums come due, you continue to make transfers to the trust, and the trustee continues to make the payments to the insurance company to keep the policy in force.

Gift tax consequences

Because an ILIT is irrevocable, any cash transfers you make to the trust are considered taxable gifts.  However, if the trust is created and administered appropriately, transfers of $12,000 or less per trust beneficiary will be free from federal gift tax under the annual gift tax exclusion.

Additionally, just as each of us has a lifetime estate tax exemption, we also have a lifetime gift tax exemption, so transfers that do not fall under the annual gift tax exclusion will be free from gift tax to the extent of your available exemption.  The gift tax exemption amount is $1 million.

Crummy withdrawal rights

Generally, a gift must be a present interest gift in order to qualify for the annual gift tax exclusion.  Gifts made to an irrevocable trust, like an ILIT, are usually considered gifts of future interests and do not qualify for the exclusion unless they fall within an exception.  One such exception is when the trust beneficiaries are given the right to demand, for a limited period of time, any amounts transferred to the trust.  This is referred to as Crummey withdrawal rights or powers.  To qualify your cash transfers to the ILIT for the annual gift tax exclusion, you must give the trust beneficiaries this right.

The trust beneficiaries must also be given actual written notice of their rights to withdraw whenever you transfer funds to the ILIT, and they must be given reasonable time to exercise their rights (30 to 60 days is typical).  It’s the duty of the trustee to provide notice to each beneficiary.  Of course, so as not to defeat the purpose of the trust, the trust beneficiaries should not actually exercise their Crummey withdrawal rights, but should let their rights lapse.

For more information on financial planning, visit www.iamllc.biz 

Is 62 your lucky number? If you’re eligible, that’s the earliest age you can start receiving Social Security retirement benefits. If you decide to start collecting benefits before your full retirement age (which ranges from 65 to 67, depending on the year you were born), you’ll be in good company. According to the Social Security Administration (SSA), approximately 73% of Americans elect to receive their Social Security benefits early. (Source: SSA Annual Statistical Supplement, June 2007)

Although collecting early retirement benefits makes sense for many people, there’s a major drawback to consider: if you start collecting benefits early, your monthly retirement benefit will be permanently reduced. So before you put down the tools of your trade and pick up your first Social Security check, there are some factors you’ll need to weigh before deciding whether to start collecting benefits early.

What will your retirement benefit be?

The exact amount of your Social Security retirement benefit is based on the number of years you’ve been working and the amount you’ve earned. Your benefit is calculated using a formula that takes into account your 35 highest earnings years. If you earned little or nothing in several of those years (if you left the workforce to raise a family, for instance), it may be to your advantage to work as long as possible, because you’ll have the opportunity to replace a year of lower earnings with a higher one, potentially resulting in a higher retirement benefit.

Each year, you’ll receive a Social Security Statement from the SSA that summarizes your earnings history, and estimates the benefits you may receive based on those earnings.

If you begin collecting retirement benefits at age 62, each monthly benefit check will be 20% to 30% less than it would be at full retirement age. The exact amount of the reduction will depend on the year you were born. (Conversely, you can get a higher payout by delaying retirement past your full retirement age–the government increases your payout every month that you delay retirement, up to age 70.)

However, even though your monthly benefit will be 20% to 30% less if you begin collecting retirement benefits at age 62; you might receive the same or more total lifetime Social Security benefits as you would have had you waited until full retirement age to start collecting benefits. That’s because even though you’ll receive less money per month, you might receive more benefit checks.

The following chart shows how much an estimated $1,000 monthly benefit at full retirement age would be worth if you started taking a reduced benefit at age 62.

** Source: Social Security Administration

Have you thought about your longevity?

Is it better to take reduced benefits at age 62 or full benefits later? The answer depends, in part, on how long you live. If you live longer than your “break-even age,” the overall value of your retirement benefits taken at full retirement age will begin to outweigh the value of reduced benefits taken at age 62.

You’ll generally reach your break-even age about 12 years from your full retirement age. For example, if your full retirement age is 66, you should reach your break-even age at 78. If you live past this age, you’ll end up with higher total lifetime benefits by waiting until full retirement age to start collecting; otherwise, collecting benefits at age 62 may be better. The SSA has a break-even calculator on its website if you want to learn more.

Of course, no one can predict exactly how long they’ll live. But by taking into account your current health, diet, exercise level, access to quality medical care, and family health history, you might be able to make a reasonable assumption.

How much income will you need?

Another important piece of the puzzle is to look at how much retirement income you’ll need, based partly on an estimate of your retirement expenses. If there is a large gap between your projected expenses and your anticipated income, waiting a few years to retire and start collecting Social Security benefits may improve your financial outlook.

If you continue to work and wait until your full retirement age to start collecting benefits, your Social Security monthly benefit will be larger. What’s more, the longer you stay in the workforce, the greater the amount of money you will earn and have available to put into your overall retirement savings. Another plus is that Social Security’s annual cost-of-living increases are calculated using your initial year’s benefits as a base–the higher the base, the greater your annual increase.

Do you plan on working after age 62?

Another key factor in your decision is whether or not you plan to continue working after you start collecting Social Security benefits at age 62. That’s because income you earn before full retirement age may reduce your Social Security retirement benefit. Specifically, if you are under full retirement age for the entire year, $1 in benefits will be withheld for every $2 you earn over the annual earnings limit ($13,560 in 2008).

Example: You start collecting Social Security benefits at age 62. You continue working, and your job pays $30,000 in 2008. Your annual benefit would be reduced by $8,220 ($30,000 minus $13,560, divided by 2).

A higher earnings limit applies in the year you reach full retirement age, and the calculation is different too–$1 in benefits is withheld for every $3 you earn over $36,120 (in 2008). Once you reach full retirement age, you don’t need to worry about your earnings. You can earn as much as you want without affecting your Social Security benefit.

Note: If your monthly benefit is reduced in the short term due to your earnings, you’ll receive a higher monthly benefit later. That’s because the SSA recalculates your benefit when you reach full retirement age, and omits the months in which your benefit was reduced.

Are you eligible for retiree health benefits?

Even if you start collecting Social Security benefits at age 62, keep in mind that you still won’t be eligible for Medicare until you reach age 65. So unless you’re eligible for retiree health benefits through your former employer or your spouse’s health plan at work, you’ll probably want to pay for a private health policy until Medicare kicks in.

Other considerations

In addition to the factors discussed here, other personal considerations may influence whether you start collecting Social Security benefits at age 62. Is your spouse already retired or planning to retire early too? Do you plan on traveling, volunteering, going back to school, starting your own business, pursuing hobbies, or moving to a new location? Do you have grandchildren or elderly parents whom you want to help take care of? Every person’s situation is different.

For more information

The nuances of Social Security can be complex. For more information about Social Security benefits, visit the Social Security Administration website at www.ssa.gov, or call (800) 772-1213 to speak with a representative. You may also call or visit your local Social Security office.

For more information on financial planning, visit www.iamllc.biz 

Bank charges can be difficult to understand and seem to sneak up on you when you aren’t looking, but with a little understanding you can watch for any bank charge and learn how to claim bank charges in the correct way. PPI (Payment Protection Insurance) may seem like another language when you hear it, but in reality you are likely paying it on multiple accounts meaning the bank is making free money off you. Credit Charges You can reclaim your PPI payments and reclaim other bank funds, even if you have gone over the limits of your account and had to pay for those mistakes. Before you start the process of trying to reclaim your bank and PPI charges, you should understand what those charges are and why you paid them in the first place. Bank accounts and loans are set up with a standard range of charges and fees that are designed to keep your accounts active, valid and managed in a responsible way. These fees can be small and when paid over time can add up to a nice refund for you, but if you have ever been hit with multiple overdraft fees at once, then you know the chunk of money they can take away and how devastating that can be. Though you pay a PPI charge to protect your account, if you never need the protection you should be able to get that amount back, right? When you file a PPI claim you should consider the length of your account, the number of PPI payments you’ve made and the lack of mistakes you have made that the coverage didn’t need to cover. Mis Sold This is all how you prove to the bank that you should receive that money back and how as a responsible financial account holder, you are entitled to receive a refund on the money you have invested into having an account with them. Bank charges are overwhelming and confusing, but with a little understanding of the bank charges you are subjected to you can get back the money you’ve been paying for years in charges and fees. When looking for a way to cut your financial costs, take the time to find out how to file a refund claim against the bank charges and PPI payments you’ve been paying over the life of your financial accounts.