Insurance and Trusts as Tools for Private Wealth Planning

Insurance and Trusts as Tools for Private Wealth Planning
John F. Kennedy once said: “The time to repair the roof is when the sun is shining,” and this rings particularly true with regard to private wealth/estate planning. Estate planning is one of the legal instruments for preventing undue concentration of wealth through a tax-efficient asset distribution prior to death.¹ It depends largely on determining the right time as well as the right mode for the transfer of assets.

There are a number of tools in estate planning, which includes, among others: (i) executing a will; (ii) entering into life insurance policies; and (iii) establishing a trust. As jurisprudentially established, a taxpayer has the legal right to decrease the amount of what otherwise could be his taxes or altogether avoid them, by means which the law permits.² These tools provide an opportunity for a taxpayer to avoid the burden of substantial estate tax liabilities on the part of his heirs.

Upon the death of the decedent, succession takes place and the right of the State to tax the privilege to transmit the estate vests instantly upon death.³ Estate tax is a tax on the right of the decedent to transmit his estate to his lawful heirs and beneficiaries at the time of death and on certain transfers, which are made by law as equivalent to testamentary disposition.4 Under the National Internal Revenue Code, as amended (the “Tax Code”), the net estate of every decedent, whether resident or non-resident of the Philippines, shall be subject to an estate tax at the rate of six percent (6%) based on the value of such net estate.⁵

One of the most common estate planning tools is executing a will. Under Article 783 of Republic Act No. 386 or the Civil Code of the Philippines (the “Civil Code”), a will is an act whereby a person is permitted, with the formalities prescribed by law, to control to a certain degree the disposition of his estate, to take effect after his death. The decedent’s net estate at the time of death shall be subject to estate tax.

By way of illustration, assuming the value of the net estate of a decedent is PhP1 Million. The estate tax payable is computed as follows:

Notably, Article 838 of the Civil Code provides that no will shall pass either real or personal property unless it is proved and allowed in accordance with the Rules of Court. A will must be validated through probate proceedings in order to ensure due execution in accordance with Philippine laws. Hence, on top of the substantial estate tax payable, the decedent’s heirs are burdened with protracted probate proceedings and likely significant court and attorney’s fees.

TRUSTS

A trust is a common estate planning tool used to minimize the burden of estate taxes. A trust is the legal relationship between one person having an equitable ownership of property and another person owning the legal title to such property, the equitable ownership of the former entitling him to the performance of certain duties and the exercise of certain powers by the latter⁶. In this arrangement, the trustor may transfer the legal title of his assets to a trustee during his lifetime who shall be responsible in distributing the same upon the trustor’s death. In essence, trusts provide a way of locking in the estate tax at an earlier point during the grantor’s lifetime necessarily avoiding the economic effects of inflation and value depreciation.

For purposes of taxation, there are two (2) types of trusts: (i) revocable trusts; and (ii) irrevocable trusts.

In a revocable trust, the trustor has the power to alter, amend or revoke the terms and conditions by which the trust was established.⁷ Essentially then, the trustor retains ownership over the assets placed under the revocable trust and, upon the trustor’s death, the assets under the revocable trust shall be included in the trustor’s gross estate.⁸ Accordingly, transfers of assets thereunder shall be subject to estate tax to the extent of the decedent’s interest therein at the time of death pursuant to Section 85(C) of the Tax Code.⁹ Further, under Sections 63 and 64 of the Tax Code, income from revocable trusts shall be included in computing the taxable income of the trustor.

Conversely, in an irrevocable trust, the trust may not be revoked after its creation^.10 Property is then already transferred at the time it is placed in the trust in favor of a designated beneficiary. The transfer is in effect, treated as a donation for tax purposes and is subject to a donor’s tax based on value of the property at the time it was transferred to the trust.

From the foregoing, assets placed under a revocable trust are subject to the estate tax based on the value of the property at the time of the trustor’s death, wherein the value is presumptively higher than the value of the property if it were transferred during the lifetime of the trustor. Assets placed under an irrevocable trust shall be subject to donor’s tax based on the value of the property at the time of creation of the trust, and not at its appreciated value at the time of the trustor’s death.

In the same scenario above, assuming the decedent decides to either transfer his net estate of PhP1 Million to a revocable and an irrevocable trust ten (10) years prior to his death. The assets placed under the revocable trust shall be subject to estate tax based on the value of the decedent’s net estate at the time of his death. On the other hand, the assets placed under an irrevocable trust shall be subject to donor’s tax based on the value of the property at the time of transfer, i.e., ten (10) years prior to the trustor’s death. Assuming the value of the property ten (10) years prior to the trustor’s death is PhP500,000.00, the respective tax implications are computed as follows:

It is important to remember, however, that the distribution of the estate of a decedent to any person other than his/her compulsory heirs shall be subject to the limitation on legitime. A legitime is that part of the decedent’s property which cannot be given away because the law has reserved it for the decedent’s compulsory heirs.¹¹Under the Civil Code, “compulsory heirs” include the surviving spouse and the children whether legitimate or illegitimate.¹²

This means that certain persons are mandated by law to be the heirs of the decedent and are entitled to a specific portion of the estate. Under Philippine succession laws, only the free portion of the decedent’s estate may be distributed to third parties, non-compulsory heirs, or even compulsory heirs, in excess of their legitime. Thus, in the event that the assets subject of a trust form part of the legitime of any of the trustor’s legal and compulsory heirs, any condition imposed to qualify the heirs to be entitled to the assets subject of the trust may be entirely disregarded with respect to the legitime of the compulsory heirs.

Philippine Law provides for the specific legal causes wherein a compulsory heir may be disinherited and deprived of his/her legitime. Disinheritance can only be effected through a will wherein the legal cause therefor shall be specified.¹³

LIFE INSURANCE

Taking out life insurance policies is  also one of the ways of easing the tax burden of the decedent and his heirs by way of indirectly transferring property to the heirs during his lifetime, only to take effect upon his death. Notably, Section 32(B)(1) of the Tax Code excludes life insurance proceeds from the gross income of the heirs and hence, shall be exempt from income tax.

With respect to estate tax, proceeds from life insurance policies shall not form part of the decedent’s gross estate and shall not be subject to estate tax, provided the following conditions  are complied with:

1. The life insurance policy is taken out by the decedent upon his own life;
2. The designation of the beneficiary is irrevocable; and
3. The decedent does not appoint any of the beneficiaries as an executor/administrator of his estate.¹⁴

Thus, whether or not the proceeds from the life insurance policies are subject to estate tax will depend for one, on the designation of the beneficiary thereof. Where the designation of the beneficiary is revocable, the proceeds of a life insurance policy shall necessarily form part of the gross estate of the

insured upon his death, and hence be subject to estate tax.[1] Conversely, where the designation of the beneficiary is irrevocable, there is immediate vesting of the right to the proceeds of the life insurance policy on the part of the beneficiary. Hence, the proceeds will no longer form part of the gross estate of the decedent and will not be subject to estate tax.¹⁶

In the same scenario above, say the decedent decides to take out a life insurance policy with a face amount of PhP1 Million, this amount will not form part of his net estate and shall not be subject to any estate tax.

Notably, and depending on the terms of the policy and the premium payable, the standard rate of return or guaranteed death benefit can range up to 200% of the face amount of the policy. To wit, for a life insurance policy with a face amount of PhP1 Million, the heirs may receive PhP2 Million upon the death of the insured. Further, there is no law which prohibits taking out more than one (1) life insurance policy upon one’s own life. Hence, you can take out as many life insurance policies as you wish.

All in all, estate planning can be a daunting task which most people avoid or delay throughout their life. It is, however, essential that you select an advisor that will, not only prepare the necessary documentation, but also help you in evaluating your goals and assist you in ensuring that your estate plan is occasionally reviewed and updated to accommodate changes in assets, goals, family or beneficiary composition and applicable tax laws.

Author Biographies

Mandy Therese M. Anderson is a Partner with expertise in taxation, corporate, and commercial law. She has over eight years of experience and specializes in mergers and acquisitions across various industries. As a CPA Lawyer, she routinely advises a wide range of clients on national and local taxation and customs regulations.

CONTACT EMAIL: mm.anderson@thefirmva.com

Ma. Samira C. Tacandong is an Associate of the Firm. Her practice areas primarily focus on taxation, financial technology, mergers and acquisitions, corporate rehabilitation and liquidation, and general corporate and commercial law.
CONTACT EMAIL: sc.tacandong@thefirmva.com

[1] NTRC. 2011. Situationer on Estate Taxation in the Philippines: Issues and Prospects, July – August 2011. National Tax Research Center.

[2]        Liddell & Co., Inc. v. The Collector of Internal Revenue, G.R. No. L-9687, 30 June 1961, citing Gregory v. Helvering, 293 U.S. 465, 7 L. ed. 596.

[3] Revenue Regulations No. 12-2018)

[4] From BIR’s official website, https://www.bir.gov.ph/index.php/tax-information/estate-tax.html#:~:text=Estate%20Tax%20is%20a%20tax,not%20a%20tax%20on%20property, last accessed on 09 August 2023.

[5] Section 84 of the NIRC as amended, Revenue Regulations 12-2018.

[6] Cañezo v. Rojas, G.R. No. 148788, November 23, 2007

[7] Section 85(C), Tax Code.

[8] BIR Ruling No. 134-16, 18 April 2016.

[9] BIR Ruling No. 013-05, 16 August 2005.

[10] BIR Ruling No. 003-05, 22 July 2005

[11]    Article 886, Civil Code.

[12]      Article 887, Civil Code.

[13]      Article 916, Civil Code.

[14]       Section 85(E), Tax Code.

[15]        BIR Ruling No. 166-93, 03 May 1993.

[16]       BIR Ruling No. 310-87, 07 October  1987.