Free Chartered Life Underwriter (CLU) Fundamentals of Estate Planning Questions and Answers — Questions and Answers
Question 1: Which of the following is a primary reason for establishing a revocable living trust as part of an estate plan?
- To permanently shield assets from all creditors during the grantor's lifetime.
- To eliminate the need for a last will and testament entirely.
- To allow assets to pass to beneficiaries while avoiding the probate process. (Correct answer)
- To reduce the grantor's income tax liability during their lifetime.
Correct answer: To allow assets to pass to beneficiaries while avoiding the probate process.
A primary advantage of a revocable living trust is that assets properly funded into the trust can pass to the designated beneficiaries upon the grantor's death without going through the time-consuming, costly, and public process of probate. While a 'pour-over' will is still necessary, the trust is the main vehicle for asset distribution. It does not offer ultimate creditor protection (as an irrevocable trust might) nor does it typically alter the grantor's income tax situation, as the grantor retains control over the assets.
Question 2: A client grants her spouse a power of appointment over assets in a trust, allowing the spouse to appoint the assets to anyone, including himself, his estate, or his creditors. How is this power of appointment classified for estate tax purposes?
- A special power of appointment
- A limited power of appointment
- A contingent power of appointment
- A general power of appointment (Correct answer)
Correct answer: A general power of appointment
A general power of appointment is defined as a power that is exercisable in favor of the powerholder, the powerholder's estate, their creditors, or the creditors of their estate. Because the spouse has the authority to appoint the assets to himself or his own estate, it is classified as a general power of appointment, which typically causes the assets to be included in the powerholder's gross estate for tax purposes.
Question 3: An individual wants to make a substantial gift to his grandchild. To prevent this transfer from being subject to the Generation-Skipping Transfer Tax (GSTT), which of the following is the MOST important factor to consider?
- The grandchild's current income level.
- Whether the gift is made outright or to a trust.
- The availability and application of the donor's lifetime GSTT exemption. (Correct answer)
- The state in which the grandchild resides.
Correct answer: The availability and application of the donor's lifetime GSTT exemption.
The Generation-Skipping Transfer Tax (GSTT) is a federal tax on transfers to 'skip persons' (like grandchildren) that exceed the lifetime GSTT exemption amount. Therefore, the most critical factor in avoiding the tax is whether the donor has a sufficient lifetime exemption to allocate to the gift. While the form of the gift (outright vs. trust) matters for planning, the exemption is the key to avoiding the tax itself.
Question 4: A primary purpose of the unlimited marital deduction in U.S. estate and gift tax law is to:
- Permanently exclude all assets transferred to a spouse from any future estate taxation.
- Allow for the tax-free transfer of assets to a U.S. citizen spouse, deferring any potential estate tax until the surviving spouse's death. (Correct answer)
- Ensure that life insurance proceeds payable to a spouse are always free of income tax.
- Permit spouses to make unlimited tax-deductible charitable contributions from the estate.
Correct answer: Allow for the tax-free transfer of assets to a U.S. citizen spouse, deferring any potential estate tax until the surviving spouse's death.
The unlimited marital deduction allows an individual to transfer an unlimited amount of assets to their U.S. citizen spouse during life or at death without incurring federal gift or estate tax. This does not permanently eliminate the tax but defers it; the assets that qualified for the deduction will be included in the surviving spouse's estate upon their death and may be subject to tax at that time.
Question 5: A wealthy client is concerned that the death benefit from their large life insurance policy will increase the size of their gross estate, potentially creating a significant estate tax liability. Which estate planning tool is specifically designed to own a life insurance policy and exclude the proceeds from the insured's taxable estate?
- A Revocable Living Trust
- A Testamentary Trust
- An Irrevocable Life Insurance Trust (ILIT) (Correct answer)
- A Charitable Remainder Trust
Correct answer: An Irrevocable Life Insurance Trust (ILIT)
An Irrevocable Life Insurance Trust (ILIT) is a specialized trust created specifically to own a life insurance policy. When properly structured and administered, the ILIT is the owner and beneficiary of the policy. This arrangement removes the policy proceeds from the insured's gross estate, thereby shielding the death benefit from federal estate taxes.
Question 6: Which of the following property ownership arrangements ensures that the property will automatically pass to the surviving owner(s) upon the death of one owner, thereby avoiding probate?
- Tenancy in Common
- Joint Tenancy with Right of Survivorship (JTWROS) (Correct answer)
- Ownership as a sole proprietor
- Community Property without right of survivorship
Correct answer: Joint Tenancy with Right of Survivorship (JTWROS)
Joint Tenancy with Right of Survivorship (JTWROS) is a form of co-ownership where, upon the death of one owner, their interest in the property automatically passes to the surviving joint tenant(s) by operation of law. This transfer occurs outside of the will and avoids the probate process. Tenancy in Common does not have a right of survivorship; the deceased's share passes through their estate.
Free Chartered Life Underwriter (CLU) Fundamentals of Estate Planning Questions and Answers
Which of the following is a primary reason for establishing a revocable living trust as part of an estate plan?