Preventive medicine: Avoid common physician estate-planning mistakes

September 1, 2009

Like many successful people, physicians are often so busy dealing with their practices and personal lives that they never take the time to deal with the important challenge of creating a tax-wise estate plan for their families. In fact, in our practices, we have found that fewer than 5 percent of doctors had a proper estate plan in place when we met.

Key Points

Like many successful people, physicians are often so busy dealing with their practices and personal lives that they never take the time to deal with the important challenge of creating a tax-wise estate plan for their families. In fact, in our practices, we have found that fewer than 5 percent of doctors had a proper estate plan in place when we met.

In this article, we will examine three of the most significant mistakes physicians make when creating (or ignoring) their family's estate plan. We'll also cover simple tools that the doctor can use to help avoid such mistakes and allow one's family to elude the unnecessary costs that come with poor planning.

Life insurance

The greatest misconception most clients have when it comes to life insurance is that the proceeds are estate tax-exempt. This is absolutely wrong! The proceeds are income tax-exempt, but are subject to both federal and state estate taxes.

Federal estate tax rates, now and under current proposals, will likely be in the 45 percent range - plus state estate and inheritance taxes, as well. Why lose a possible fortune of your policy proceeds after you paid those premiums so diligently ... especially when a well-structured trust can take the Internal Revenue Service (IRS) out of the picture and provide better protection for your beneficiaries?

Benefits of ILITs

An irrevocable life insurance trust (ILIT) is simply an irrevocable trust that owns a life insurance policy. The ILIT can save you estate taxes, because it, rather than you, personally, owns the life insurance policy. Because the policy is not owned in your name, the policy proceeds will not be part of your net estate when you die - as long as you survive three years from the transfer to the trust.

Thus, the proceeds will not be subject to the estate tax. This can save your family a great deal of money - and is a must for policies owned for estate planning purposes, as opposed to those designed to generate retirement wealth.

The ILIT gives you much more control over what happens to the policy proceeds than you would get from a bare insurance policy. With an insurance policy alone, your only decision is to whom you will leave the proceeds (the beneficiaries). The insurance company will simply pay these people when you die.

With an ILIT, on the other hand, you can control not only who gets the proceeds, but also exactly what happens to the funds when you die. You can have the trustee pay the beneficiaries directly or pay them over a period of months or years. You can incorporate spendthrift provisions and anti-alienation provisions to protect against your beneficiaries' financial problems or their spouses' financial woes.

In fact, an ILIT gives you all of the benefits of a trust arrangement, while allowing you to provide for your family just as you would with a bare insurance policy. For these reasons, an ILIT should be considered in a physician's estate plan.

Of course, there is a significant drawback to ILITs, especially for policies with cash value - once the policy is transferred to the trust, you will no longer have access to the cash value.

If you have already purchased a life insurance policy or are presently making payments on an existing policy, it is not too late. You can always transfer a policy to an ILIT. There may be some gift-tax issues associated with this maneuver, but they are likely to be minor compared to the potential tax savings your family could ultimately enjoy.