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Understanding Life Insurance Trusts 1. Why should I have a life insurance trust? Life insurance proceeds are not subject to income tax, but they are subject to estate tax. Even if the proceeds are not payable to your estate but are instead paid to a close relative, the proceeds will be considered part of your estate if you owned the policy. Unfortunately, many people are under the misconception that they do not own their policy if they are not the beneficiaries. As a general rule, if you pay the life insurance premiums from your personal funds, the life insurance proceeds will be included in your estate, even if the proceeds are payable to someone other than your estate. Furthermore, if you have the right to change the beneficiary of the policy, the proceeds will certainly be included in your estate. Thus, if a person has purchased a one million dollar life insurance policy and has other significant assets, the life insurance policy may only "net" $450,000 after estate taxes. If a life insurance trust had been utilized, the full one million dollars would have been paid without any estate taxes owed. An irrevocable life insurance trust lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones. It also gives you more control over your insurance policies and the money that is paid from them.
Depending on the value of your estate when you die, your
estate may have to pay estate taxes before your assets can be
fully distributed. Estate taxes are different from probate
expenses (which can be avoided with a revocable living trust.
To determine the net value of your estate, use the current
fair market value for all of the following: add all of your
assets, then subtract your debts. Include all real property,
business interests, stock interests, bank accounts, personal
property, IRAs and other retirement plans, and death benefits
from your life insurance. Simply put, after you create a life insurance trust, you no
longer own the policy. The policy is therefore not included in
your estate and is no longer subject to estate tax. But, if he creates a life
insurance trust, his net taxable estate remains $10,000,000 and
his family receives the full $5,000,000 insurance proceeds. If your estate will still have to pay estate taxes after you
transfer your life insurance policy into a trust, there are still
many ways in which to reduce your estate tax, as more fully
explained in the estate tax planning page. As far as the life insurance trust, you
can have the trust buy additional life insurance. There are three aspects an insurance
trust: 1) The grantor, 2) the trustee and 3) the beneficiary. You
would be the grantor, the person that creates and funds the
trust. The trustee manages the trust and would be selected by
you. The trust beneficiaries selected by you will receive the
trust assets (life insurance proceeds) after you die. You cannot be the trustee of your life insurance trust. The Tax Court has held that if a grantor (person who creates the trust) is also the trustee, the life insurance proceeds will be included in the grantor's estate. Some people name their adult children or other trusted
relatives as trustee's), but the trustee must comply with specific
rules in order for the insurance proceeds to not be part of your
net estate. As such, many people choose their lawyer or
accountant to be the trustee. Rather than creating a life insurance trust, you may have your
children own the policy. Although this can keep the life
insurance proceeds out of your estate, it has the following
disadvantages. The Trust is created by you and the trustee selected by you must follow the provisions given by you in the trust. The provisions will include who receives the money and when the money is to be received. For example, you could have direct the trust to use the
insurance proceeds to purchase assets from your estate or revocable
living trust, which would provide necessary cash to
pay probate costs. You can direct that the proceeds be invested
and pay the income to your spouse and upon your spouse's death,
the principal be distributed to your beneficiaries. You could
also direct that the insurance proceeds remain in the trust and
have the trustee make periodic distributions to the beneficiaries
of the trust. Any person can be named as a beneficiary of your life
insurance trust. Most people name their children and/or spouse as
the trust beneficiaries.. The insurance is purchased using money contributed by you - but the money must be contributed in a specific manner. Everyone knows that an individual can give up to $10,000 tax free to an individual. However, the person receiving the gift must have immediate access to it. If you transfer money directly to the trustee, the $10,000 exclusion may not apply and there could be a gift tax. To qualify for the $10,000 annual exclusion, give the trustee
the amount of money equal to the insurance premium. The trustee
must then notify each beneficiary of the trust that a gift has
been received on his/her behalf and, unless he/she elects to
receive the gift now, the trustee will invest the funds - by
paying the premium on the insurance policy. Yes, but the proceeds may be included in your net taxable
estate if you die within three years of the date of the transfer.
Also, there may be a gift tax on the transfer. Yes. Although there are many tax planning strategies that do
not require professional assistance, a life insurance trust is
not one of them. The cost of professional assistance is very
small when compared to the possibility of the proceeds being
included in your estate. If you think an irrevocable insurance
trust would be of value to you and your family, talk with an
insurance professional or estate planning attorney who has
experience with these trusts. • Visit our Acclaimed Estate Planning Education
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