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This article comes from local financial advisor Elliott Orsillo (www.seasoninvestments.com). Elliott's excellent analysis of the history and political realities of the debt ceiling debate is worth perusing. 
Hope this helps you!

The 95th Raising of the Debt Ceiling

Posted on January 15, 2013

“I can confirm we will reach the statutory debt limit today.” – US Treasury Official on December 31, 2012

debt_ceiling.jpgNow that all the political posturing surrounding the fiscal cliff is behind us, it is time for the newly elected Congress to wet their brinkmanship beaks over the debt limit placed on the US Treasury, affectionately known as the debt ceiling. As the opening quote indicates, the US Treasury reached its statutory debt limit at the end of last year. Using “extraordinary measures” and creative accounting, the Treasury thinks it can keep the US government afloat until late February or early March of this year before the debt limit will need to be raised for the 95th time in history to avoid default. 

The whole concept of a debt ceiling is a bit strange in that Congress has the power to set revenues (e.g. tax receipts) and spending, but chooses to outsource the process of issuing debt in order to fill the gap between these two (e.g. the deficit). A somewhat weak parallel can be made to a household which has a known income, the power to set spending, and credit to fill the gap between income and spending, which is extended to them by a bank. At some point, a “debt limit” is reached and banks will no longer extend credit to a household who has built up too much debt and is spending in excess of its income. This is where the analogy breaks down since our fictitious household has no control over raising its debt limit, whereas Congress has complete control over it.

The debt limit was first introduced in 1917 when Congress passed the Second Liberty Bond Act. Before this point, if Congress needed to borrow money to finance a specific plan or project, such as digging a giant canal in Panama, it would approve the sale of a lot of Treasury bonds. Each new lot of bonds was considered individually based on the merit of the need. But with the United States’ entry into the First World War, this process became much too time consuming, so Congress delegated bond issuance to the Treasury Department. The delegation did come with a major caveat which allowed Congress to cap the amount of debt the Treasury could issue by establishing a debt limit.    

Since that time, the debt limit has done very little to control the debt burden of the United States. The chart below plots the debt limit versus outstanding debt on a logarithmic scale. As a brief side note, plotting a logarithmic scale allows us to visualize percentage changes in the debt ceiling over time rather than just absolute dollar changes.


The points on the chart that have the steepest slope are the periods of time where the debt limit was increased the most as measured by the percentage change from the previous debt limit level. We see that the steepest increase was during the FDR administration in the early 40’s, which was followed by a long period of little to no increases. Then in the 1970’s with Nixon taking the US dollar off the gold standard and the embrace of Wimpy economics, the slope of the line turns up again. The slope has roughly remained the same ever since with the exception of the economic and technological boom of the late 1990’s.

It doesn’t take a genius to see that the debt limit is raised once the total outstanding debt either approaches or bumps up against the limit. The raising of the debt limit is a bipartisan practice as well. Since it was established in 1917, it has changed 104 times with 94 raises and 10 declines (although 3 of the declines only lasted for 1 day during political brinkmanship under the Carter administration). Of the 94 increases, 54 have been done under a Republican president and 40 under a Democratic president while the magnitude of the increase has been larger on average under Democrats.


The situation we find ourselves in today is similar to that of 1954 when Republican president Dwight D. Eisenhower butted heads with Democratic senator Harry F. Byrd who chaired the Senate Finance Committee. Eisenhower wanted to raise the debt limit in order to finance the build out of a national highway system. Byrd pushed back stating his concern over the apparent permanency of the national debt that had built up from the Great Depression and World War II. He demanded spending cuts be made in exchange for raising the debt limit. The Treasury had to take emergency measures to avoid default before both sides eventually came to a compromise and raised the limit while also cutting spending.

Not unlike the 1954 debate, the battle over the 95th raising of the debt ceiling has one side stating that it is for the good of the nation while the other believes it is the only tool left in the toolbox to try to reign in government spending. In reference to Congressional Republicans, President Obama stated, “They can act responsibly, and pay America's bills; or they can act irresponsibly, and put America through another economic crisis.” In response, Republican Senate Minority Leader Mitch McConnell fired back by stating that Democrats “need to get serious about spending, and the debt-limit debate is the perfect time for it.” There has even been talks of the Treasury printing a trillion dollar coin, a loophole which exploits the Treasury’s ability to mint commemorative platinum coins, to avoid the debt ceiling. Thankfully this idea has been put to bed, but it just goes to show the extremes our leaders are willing to consider due to the highly partisan and divisive atmosphere in D.C. today.

Needless to say, we are in for another drawn out debate which will be fought in the press and most likely end with a last minute fix. Our view is that this will be accompanied with short bouts of volatility over the upcoming weeks as investors and traders try to digest every tidbit of information they receive from the soon-to-be highly publicized debate. Although we don’t think the debt ceiling debate will be the catalyst that crashes the party, we do realize that there are real, unknown risks in the market that could pop up at any given moment. To quote BlackRock Investments, “the shell you can hear is not the one that hits you.”


elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.


Understanding Life Insurance Trusts

Posted on: October 18th, 2012

Understanding Life Insurance Trusts

1. What does a life insurance trust do?
An irrevocable life insurance trust gives you more control over your insurance policies and the money that is paid from them. It also lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones.

2. What are estate taxes?
Estate taxes are different from, and in addition to, probate expenses and final income taxes which are due on the income you receive in the year you die. Federal estate taxes are expensive (historically 45-55%) and they must be paid in cash, usually within nine months after you die. Because few estates have the cash, it has often been necessary to liquidate assets to pay these taxes. But if you plan ahead, estate taxes can be reduced or even eliminated.

3. Who has to pay estate taxes?
Your estate will have to pay federal estate taxes if its net value when you die is more than the exempt amount set by Congress at that time. In 2011 and 2012, the federal exemption is $5 million (adjusted for inflation in 2012) and the tax rate is 35%. If Congress does not act before the end of 2012, the exemption in 2013 will be $1 million and the top tax rate will be 55%. Some states have their own death or inheritance tax, so your estate could be exempt from federal tax and still have to pay state tax.

Year of Death Exempt Amount Top Tax Rate
2011 and 2012 $5 million* 35%
2013 and thereafter $1 million 55%

*Adjusted for inflation in 2012.

4. What makes up my net estate?
To determine your current net estate, add your assets then subtract your debts. Insurance policies in which you have any "incidents of ownership" are included in your taxable estate. This includes policies you can borrow against, assign or cancel, or for which you can revoke an assignment, or can name or change the beneficiary. You can see how life insurance can increase the size of your estate and the amount of estate taxes that must be paid.

5. How does an insurance trust reduce estate taxes?
The insurance trust owns your insurance policies for you. Since you don't personally own the insurance or have any incidents of ownership, it will not be included in your estate -- so your estate taxes are reduced. (There is a three-year rule for existing policies, which is explained later.)

With the exemption at $5 million, you may not need the estate tax savings right now. But it's important to understand how this works, because the exemption may be reduced as soon as 2013 and the value of your net estate may increase substantially by the time you die.

Let's say you are married, with a combined net estate of $3 million, $1 million of which is life insurance, and both you and your spouse die when the estate tax exemption is $1 million and the top tax rate is 55%. A tax planning provision in a living trust or a will could protect up to $2 million from estate taxes. But your estates would have to pay $435,000 in estate taxes on the additional $1 million. With an insurance trust, the $1 million in insurance would not be in your estate. That would save your family $435,000 in estate taxes.

6. What if my estate is larger than this?
If your estate will still have to pay estate taxes after you transfer your insurance to a trust, you can reduce your estate tax costs -- by having the trust buy additional life insurance. Here are three very good reasons to do this:

  1. If the trust buys the insurance, it will not be included in your estate. So the proceeds, which are not subject to probate or income taxes, will also be free from estate taxes.
  2. Insurance proceeds are available right after you die. So your assets will not have to be liquidated to pay estate taxes.
  3. Life insurance can be an inexpensive way to pay estate taxes and other expenses. So you can leave more to your loved ones.

7. How does an irrevocable insurance trust work?
An insurance trust has three components. The grantor is the person creating the trust -- that's you. The trustee you select manages the trust. And the trust beneficiaries you name will receive the trust assets after you die.

The trustee purchases an insurance policy, with you as the insured, and the trust as owner and (usually) beneficiary. When the insurance benefit is paid after your death, the trustee will collect the funds, make them available to pay estate taxes and/or other expenses (including debts, legal fees, probate costs, and income taxes that may be due on IRAs and other retirement benefits), and then distribute them to the trust beneficiaries as you have instructed.

8. Can I be my own trustee?
Not if you want the tax advantages we've explained. Some people name their spouse and/or adult children as trustee(s), but often they don't have enough time or experience. Many people choose a corporate trustee (bank or trust company) because they are experienced with these trusts. A corporate trustee will make sure the trust is properly administered and the insurance premiums promptly paid.

9. Why not just name someone else as owner of my insurance policy?
If someone else, like your spouse or adult child, owns a policy on your life and dies first, the cash/termination value will be in his/her taxable estate. That doesn't help much.

But, more importantly, if someone else owns the policy, you lose control. This person could change the beneficiary, take the cash value, or even cancel the policy, leaving you with no insurance. You may trust this person now, but you could have problems later on. The policy could even be garnished to help satisfy the other person's creditors. An insurance trust is safer; it lets you reduce estate taxes and keep control.

10. How does an insurance trust give me control?
With an insurance trust, your trust owns the policy. The trustee you select must follow the instructions you put in your trust. And with your insurance trust as beneficiary of the policies, you will even have more control over the proceeds.

For example, your trust could allow the trustee to use the proceeds to make a loan to or purchase assets from your estate or revocable living trust, providing cash to pay taxes and expenses. You could provide your spouse with lifetime income and keep the proceeds out of both of your estates. You could keep the money in the trust for years and have the trustee make distributions as needed to trust beneficiaries, which can include your children and grandchildren. Proceeds that stay in the trust can be protected from courts, creditors (even spouses) and irresponsible spending.

By contrast, if your spouse or children are beneficiaries of the policy, you will have no control over how the money is spent. If your spouse is beneficiary and you die first, all of the proceeds will be in your spouse's taxable estate; that could create a tax problem. Also, your spouse (not you) will decide who will inherit any remaining money after he or she dies.

11. Are there other benefits to naming the trust as beneficiary of an insurance policy?
Yes. If you name an individual as beneficiary of a policy and that person is incapacitated when you die, the court will probably take control of the money. Most insurance companies will not knowingly pay to an incompetent person, and will usually insist on court supervision. But if your trust is beneficiary of the policy, the trustee can use the proceeds to provide for your loved one without court interference.

12. Who can be beneficiaries of the trust?
You can name any person or organization you wish. Most people name their spouse, children and/or grandchildren.

13. Where does the trustee get the money to purchase a new insurance policy?
From you, but in a special way. If you transfer money directly to the trustee, there could be a gift tax. But you can make annual tax-free gifts of up to $13,000 ($26,000 if your spouse joins you) to each beneficiary of your trust. (Amounts may increase periodically for inflation.) If you give more than this, the excess is applied to your federal gift/estate tax exemption.

Instead of making a gift directly to a beneficiary, you give it to the trustee for the benefit of each beneficiary. The trustee notifies each beneficiary that a gift has been received on his/her behalf and, unless the beneficiary elects to receive the gift now, the trustee will invest the funds -- by paying the premium on the insurance policy. Each beneficiary must understand the consequences of taking the gift now; for example, it may reduce the trustee's ability to pay premiums.

14. Are there any restrictions on transferring my existing policies to an insurance trust?
Yes. If you die within three years of the date of the transfer, it will be considered invalid by the IRS and the insurance will be included in your taxable estate. There may also be a gift tax. Be sure to discuss this with your advisor.

15. Can I make any changes to the trust?
An insurance trust is irrevocable, which generally means you cannot make changes to it. However, under the Uniform Trust Code (UTC) and decanting provisions in some states, you may be able to make some changes. Still, you should read the trust document carefully before you sign it.

16. When should I set up an insurance trust?
You can set up one at any time, but because the trust is irrevocable many people wait until they are in their 50s or 60s. By then, family relationships have usually settled. Just don't wait too long; you could become uninsurable. And remember, if you transfer existing policies to the trust, you must live three years after the transfer for it to be valid.

17. Should I seek professional assistance?
Yes. If you think an irrevocable insurance trust would be of value to you and your family, talk with an insurance professional, estate planning attorney, corporate trustee, or CPA who has experience with these trusts.

18. Benefits of a Life Insurance Trust

  • Provides immediate cash to pay estate taxes and other expenses after death.
  • Reduces estate taxes by removing insurance from your estate.
  • Inexpensive way to pay estate taxes.
  • Proceeds avoid probate and are free from income and estate taxes.
  • Gives you maximum control over insurance policy and how proceeds are used.
  • Can provide income to spouse without insurance proceeds being included in spouse's estate.
  • Prevents court from controlling insurance proceeds if beneficiary is incapacitated.
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