Historically, one of the main reasons to set up an irrevocable trust has been to avoid or minimize any potential estate tax, but now there are other planning purposes for these trusts.
An advantage of life insurance trust is that it removes the life insurance from the estate of the insured. Please note that I am not an attorney, and this is not to be used as legal advice.
Despite the advantages of an irrevocable life insurance trust (ILIT), it is important for anyone thinking about setting one up to keep these points in mind:
· If you transfer an existing life insurance policy into the ILIT and die within three years of the transfer, then the policy will revert back to your estate and will be subject to estate taxes.
· The trust is irrevocable – if it is your trust and you are funding it with a life insurance policy, you are considered the grantor. Meaning, you must give up complete control and will not have any rights including changing the beneficiary, making policy loans, withdrawing funds, and terminating the policy.
· Once a payment is made into the trust, the trustee will send out a letter under the gift-tax exclusion rules, also known as the Crummy Provision. This letter allows beneficiaries a 30-day period wherein they have the opportunity to withdraw their share.
· Enables the grantor to leverage the annual gift-tax exclusion to a much larger sum of money, through the purchase of life insurance.
· Provides the insured’s heirs estate liquidity on a transfer tax-free basis.
· Replaces estate assets used to pay estate taxes or to provide a charitable request.
· Gives the grantor the opportunity to control the distribution of the death proceeds through the trust provisions in a manner consistent with overall estate objectives.
· Protects the trust assets from the trust beneficiaries’ creditors.
· The heirs are not obligated to use the proceeds to pay the estate taxes.
You should carefully consider who the trustee is and discuss the ramifications with your attorney.
Special Considerations of Life Insurance
An example: If the owner resides in a community-property state and the policy is purchased with community-property funds, one-half of the proceeds are owned by the surviving spouse, no matter who policy names as the beneficiary.
This result can be varied by a written agreement between the spouses, which one spouse transfers all interest in a particular insurance policy to the other spouse. Insurance companies should supply this form upon request.
Please consult with a qualified estate planning attorney before setting up a trust like this, as I am not an attorney.
(Plan Your Estate, NOLO Press.)
Steuer, author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, has more than 25 years of experience and holds the Department of Insurance Analyst License (LA) as well as the Charted Life Underwriter (CLU) designation. Tony holds various leadership positions and has authored three books on the topic of life insurance.
Steuer’s work has been awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy for his The Questions and Answers on Disability Insurance Workbook and The Questions and Answers on Insurance Planner. Forbes named Questions and Answers on Life Insurance: The Life Insurance Toolbook as one of their top nine great investment books.
He’s also the founder of the Insurance Literacy Institute and creator of The Insurance Bill of Rights designed to empower consumers and to identify members of the Insurance Industry dedicated to strong professional standards.
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