In a decision that is sending shudders through the estate planning and life insurance worlds, a federal judge has ruled a multimillion-dollar life insurance policy in Maryland void because it was owned by a trust. In the judge's view, Maryland law bars a trust from having an "insurable interest" in a person.
That legal interpretation, if sustained on appeal and widely applied, would undermine a key estate planning strategy, which takes advantage of the fact that the payout from life insurance policies not owned by the insured person can escape both income and estate taxes. It is common practice to place life policies, especially large ones, in irrevocable trusts.
Planners have been using this strategy for decades, and today the vast majority of large cash-value insurance policies are sold to trusts, experts say.
This ruling -- finding a policy held in trust to be void -- "is going to set the financial planning community on its head," said Washington attorney William H. Crispin, who represents the trustee whose claim for payment under the policy was rejected by the insurance company.
The ruling, agreeing with a defense raised by the insurance company, is based on Maryland law, but a half-dozen other states have statutes worded much like Maryland's, Crispin said.
The case involved what one attorney called "weird facts," which officials of the American Council of Life Insurers, a trade group, and Maryland insurance regulators said may limit the ruling's impact. Also, an appeal is pending.
But others who have seen the ruling by U.S. District Judge Claude M. Hilton in Alexandria find it alarming.
"It could turn out to be a bad thing, or be completely ignored," said Alan L. Meltzer of the Meltzer Group in Bethesda, which specializes in high-end insurance policies for estate planning and other purposes. But "it's dangerous because another court could" decide to follow it, he said.
Estate planning lawyer Frederick J. Tansill of McLean called the ruling "very troubling."
"If this ruling stands, the collectibility of billions, or even trillions, of dollars of life insurance on the wealthiest Americans may be in doubt," Tansill said. "This is frankly an unimaginable result."