CLU Estate Planning Practice Questions
Question 1
A client wants to use life insurance to fund estate liquidity through an ILIT while completely avoiding any risk of the three-year lookback rule under IRC Section 2035. Which strategy accomplishes this?
- A. Have the ILIT apply for and be named as the original applicant, owner, and beneficiary of a brand-new policy on the client's life, rather than transferring an existing policy into the trust
- B. Purchase the policy in the client's own name first, then change the beneficiary designation to the ILIT immediately after issue
- C. Transfer an existing policy to the ILIT, but have the client continue paying all future premiums directly to the insurer
- D. Transfer an existing policy to the ILIT and simply wait 36 months and one day before the client dies
Show answer and explanation
Correct answer: A. Have the ILIT apply for and be named as the original applicant, owner, and beneficiary of a brand-new policy on the client's life, rather than transferring an existing policy into the trust
The Section 2035 three-year lookback applies only when the insured transfers an existing policy (or relinquishes incidents of ownership in one) that he or she previously owned. If the ILIT itself is the original applicant and owner from inception — meaning the insured never personally owned the policy or held incidents of ownership — there is no 'transfer' to look back on, so Section 2035 is never implicated, regardless of how soon death occurs. Option B still involves the client owning the policy first. Option C doesn't fix the fact that a transfer of an existing policy occurred (grantor paying premiums is a separate gift-tax issue, not a cure for 2035). Option D correctly describes surviving the lookback period but is not a strategy that 'avoids the rule entirely' — it depends on the client outliving an uncertain window.
- A. Correct. If the ILIT applies for, owns, and is named beneficiary of a brand-new policy from day one, the insured never personally owned or transferred the policy, so there is nothing that could trigger the §2035 three-year lookback.
- B. Incorrect — retaining ownership and merely changing the beneficiary designation doesn't remove the policy from the insured's estate at all, since the insured still holds incidents of ownership under §2042.
- C. Incorrect — transferring an existing policy to the ILIT still starts the three-year clock under §2035, and having the client keep paying premiums directly can create additional gift and inclusion issues.
- D. Incorrect — this strategy still carries real risk of estate inclusion if the client dies within three years of the transfer; it does not avoid the lookback, it just hopes to outlast it.
Question 2
When an existing, previously-issued life insurance policy is gifted to an ILIT, what value is used to determine the amount of the taxable gift?
- A. The policy's interpolated terminal reserve value plus any unearned premium — approximately the policy's cash value, not the death benefit
- B. The full face amount of the death benefit
- C. The total premiums the insured would have paid over his or her remaining life expectancy
- D. Zero, because transfers to an irrevocable trust are never treated as gifts
Show answer and explanation
Correct answer: A. The policy's interpolated terminal reserve value plus any unearned premium — approximately the policy's cash value, not the death benefit
For gift tax purposes, an existing policy is valued using its interpolated terminal reserve plus any unearned premium — a figure that closely tracks the policy's cash surrender value, not its face amount. This is far lower than the death benefit, which is why gifting an existing policy is often gift-tax-efficient relative to the protection it provides. Choice D is wrong because a transfer of a valuable asset to an irrevocable trust is a completed gift.
- A. The taxable gift value of an existing policy transferred to an ILIT is measured by its interpolated terminal reserve plus any unearned premium — essentially the policy's cash value, not its face amount.
- B. The full face amount of the death benefit isn't used to value the gift of an in-force existing policy; that would drastically overstate the value transferred.
- C. Total future premiums over life expectancy isn't the valuation method for gifting an existing, previously-issued policy.
- D. Transferring an existing policy with real value into an irrevocable trust is generally a taxable gift; it isn't automatically valued at zero.
Question 3
How does a QTIP (Qualified Terminable Interest Property) trust differ from a standard bypass (credit shelter) trust in estate planning?
- A. A QTIP trust qualifies for the marital deduction while giving the grantor control over the ultimate remainder beneficiaries, whereas a bypass trust uses the decedent's own applicable exclusion amount and does not qualify for the marital deduction
- B. A bypass trust qualifies for the marital deduction and defers tax until the surviving spouse's death, whereas a QTIP trust uses the decedent's applicable exclusion amount and does not qualify for the marital deduction, and the surviving spouse alone chooses the remainder beneficiaries of the bypass trust
- C. The two trusts are treated the same way for estate tax purposes, since each qualifies for the marital deduction and allows the surviving spouse to decide who receives the remainder at death
- D. A QTIP trust is typically funded with life insurance proceeds payable to the surviving spouse, whereas a bypass trust is typically funded with the decedent's retirement accounts rather than insurance
Show answer and explanation
Correct answer: A. A QTIP trust qualifies for the marital deduction while giving the grantor control over the ultimate remainder beneficiaries, whereas a bypass trust uses the decedent's own applicable exclusion amount and does not qualify for the marital deduction
A QTIP trust lets the decedent secure the marital deduction (deferring tax to the surviving spouse's death) while still dictating who receives the trust remainder after the spouse dies — useful in blended-family planning. A bypass/credit shelter trust instead uses the decedent's own applicable exclusion amount at the first death, deliberately not qualifying for the marital deduction, so those assets (and their appreciation) escape tax at the second spouse's death too.
- A. Correct. A QTIP trust qualifies for the marital deduction while letting the grantor control who ultimately receives the remainder, whereas a bypass trust uses the decedent's own applicable exclusion amount and does not qualify for the marital deduction.
- B. This reverses the roles — it's the QTIP trust, not the bypass trust, that qualifies for the marital deduction, and the grantor, not the surviving spouse, generally controls the remainder beneficiaries.
- C. The two trust types serve materially different purposes: a QTIP qualifies for the marital deduction with grantor-controlled remainder, while a bypass trust uses the exclusion amount and does not qualify for the marital deduction.
- D. The distinction between the trusts is not the type of asset funding them; a QTIP trust can hold a variety of estate assets, and the real differences are marital deduction treatment and use of the exclusion amount.
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The annual gift tax exclusion allows a donor to give up to a set amount per donee, per year, without using any of the donor's lifetime unified credit or filing a gift tax return, provided the gift qualifies as a present interest. Which statement correctly reflects a limitation on this exclusion?
- A. Gifts of a future interest, such as most contributions to certain trusts without withdrawal rights, do not qualify for the annual exclusion
- B. The exclusion applies automatically to gift-splitting by a married couple, so no consent, election, or gift tax return is required from the spouses
- C. The exclusion applies only to outright gifts of cash, and never to gifts of other property or to life insurance premiums paid on a policy owned by the donee
- D. The exclusion amount is fixed permanently by statute and never adjusts for inflation, so it has stayed the same since it was first enacted
Show answer and explanation
Correct answer: A. Gifts of a future interest, such as most contributions to certain trusts without withdrawal rights, do not qualify for the annual exclusion
The annual gift tax exclusion is available only for gifts of a present interest — meaning the donee has an immediate, unrestricted right to use, possess, or enjoy the gift. Contributions to most irrevocable trusts are future interests unless the trust includes a mechanism, such as Crummey withdrawal rights, that converts the gift into a present interest. Gift-splitting between spouses is a real technique that can double the effective exclusion, but it requires the couple's consent/election, not automatic application.
- A. Correct — present-interest requirement is the key limitation, and future-interest gifts (without a present-interest mechanism like Crummey powers) don't qualify.
- B. Incorrect — gift-splitting requires spousal consent and election (typically on a gift tax return); it is not automatic.
- C. Incorrect — the exclusion applies to gifts of property generally, including insurance premiums paid for another's benefit, not only cash.
- D. Incorrect — the exclusion amount is periodically adjusted for inflation, and has changed over time.