Remember the monsters that used to hide under your bed?

We found some of them in our clients' estate plans.

Every advisor specializing in estate analysis appreciates the role life insurance can play in a sound strategy. For funding most estates' liquidity needs, insurance is unmatched for its versatility. But it's also true that life insurance -- improperly used -- can create nightmares for a client's estate.

At Stern Slavutin-2, we keep our clients alert to the tax implications (estate, gift, and income taxes) of any plan -- or change of plan -- they're considering. Here are a few examples of the missteps we help them avoid…

• The "Inadvertent" Gift: A person owns life insurance on the life of another, and designates a third person as beneficiary. A classic example: a wife owns a life insurance policy on the life of her husband, and names their child as beneficiary. The IRS may hold that the owner made a taxable gift of the proceeds to the beneficiary (Rev. Rul. 81-166; Goodman).

• The Badly Drafted Trust: The objectives of the irrevocable life insurance trust - removing insurance proceeds from estates of the insured and surviving spouse - may be undermined if a trust requires, rather than permits, the trustee to pay estate taxes with insurance proceeds. This can be fixed by creating a new trust, properly structured to avoid the transfer-for-value rule. The new trust then buys the insurance policy, rather than receiving it as a gift. This step avoids the three year rule [IRC Sec. 2035(b)(1)].

• Naming Contingent Beneficiaries: The insured, J.B., transfers all rights of policy ownership to the beneficiary, with the provision that ownership reverts to J.B. if the beneficiary predeceases him. J.B.'s reversionary right may cause the proceeds to be included in the gross estate.

Many more traps and escape maneuvers are discussed in Lee Slavutin's articles. Just click on the Publications and Bulletin page. Have a specific question? E-mail Lee at lslavutin@finsvcs.com.

Stern Slavutin - 2 Inc. is not engaged in rendering legal or accounting services. If legal or accounting advice is required, the services of a lawyer or accountant should be sought.