Can the Three-Year Rule be Avoided?

With proper planning the three year rule can sometimes be avoided. Consider a 65 year old male who purchased several large life insurance policies to protect his family while the children were growing up. The family has now grown up and money needs to be made available to pay estate taxes. The insured and his wife may decide to buy survivorship life insurance to pay estate taxes economically. The parents set up an ILIT which in turn buys a NEW life insurance policy (a Second to Die life insurance contract). This new policy is not subject to the three year rule. The existing life insurance policy on the father can be surrendered. If a large taxable gain exists, they may want consider a 1035 exchange to a Deferred or Immediate annuity. Either option would defer the gain on the existing life insurance and help generate income to offset the cost of the survivorship policy.

Assume the father is a widower in the above example and Second to Die life insurance is inappropriate. If his current life insurance policy(s) are very old and performing poorly, he may want to consider purchasing a new, more competitive policy. In this situation, he could have an ILIT set up and have it purchase a new and better performing life insurance contract (please note the section on replacement). This new insurance policy would instantly be out of the estate! The old contract could be surrendered and 1035 exchanges could be considered if there was a taxable gain.

This document was last modified on July 27, 1999 by LMLeber

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