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.)
Tony Steuer is an author and advocate for financial preparedness. Tony Steuer, CLU, LA, CPFFE, helps people make sense of the financial world in a way that’s easy for them to understand. His books including, “GET READY!,” “Insurance Made Easy,” and “Questions and Answers on Life Insurance,” have won numerous awards. Tony is the founder of the GET READY! Initiative which includes the GET READY! financial organization system, the GET READY! Financial Preparedness Club, GET READY! Podcast, and the GET READY! Financial Principles, a best practices playbook for the financial services industry. Tony served as long-term member of the California Department of Insurance Curriculum Board. Tony is regularly featured in the media including the New York Times, the Washington Post, Fast Company, and other media. He has also appeared as a guest on television shows, such as ABC’s “Seven on Your Side.” Visit https://tonysteuer.com/ to join the GET READY! Financial Preparedness Club and access free resources.
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