Life Insurance Trusts

Life Insurance Trusts

1. What does a life insurance trust do?
An irrevocable life insurance trust gives you more control over your insurance policies and the money that is paid from them. It also lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones.

2. What are estate taxes?
Estate taxes are different from, but in addition to, probate expenses and final income taxes which are due on the income you receive in the year you die. Federal estate taxes are expensive (historically 45-55%) and they must be paid usually within nine months after you die. Because few estates have cash, it has often been necessary to liquidate assets to pay these taxes. But if you plan ahead, estate taxes can be reduced or even eliminated.

4. What does a life insurance trust do?

An irrevocable life insurance trust gives you more control over your insurance policies and the money that is paid from them. It also lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones.

5. What makes up my net estate?
To determine your current net estate, add your assets then subtract your debts. Insurance policies in which you have any "incidents of ownership" are included in your taxable estate. This includes policies you can borrow against, assign or cancel, or for which you can revoke an assignment, or can name or change the beneficiary. You can see how life insurance can increase the size of your estate and the amount of estate taxes that must be paid.

6. How does an insurance trust reduce estate taxes?
The insurance trust owns your insurance policies for you. Since you don't personally own the insurance or have any incidents of ownership, it will not be included in your estate -- so your estate taxes are reduced.

7. What if my estate is larger than this?
If your estate will still have to pay estate taxes after you transfer your insurance to a trust, you can reduce your estate tax costs -- by having the trust buy additional life insurance. Here are three very good reasons to do this:

  1. If the trust buys the insurance, it will not be included in your estate. So the proceeds, which are not subject to probate or income taxes, will also be free from estate taxes.
  2. Insurance proceeds are available right after you die. So your assets will not have to be liquidated to pay estate taxes.
  3. Life insurance can be an inexpensive way to pay estate taxes and other expenses. So you can leave more to your loved ones.

8. How does an irrevocable insurance trust work?
An insurance trust has three components. The grantor is the person creating the trust -- that's you. The trustee you select manages the trust. And the trust beneficiaries you name will receive the trust assets after you die.

The trustee purchases an insurance policy, with you as the insured, and the trust as owner and (usually) beneficiary. When the insurance benefit is paid after your death, the trustee will collect the funds, make them available to pay estate taxes and/or other expenses (including debts, legal fees, probate costs, and income taxes that may be due on IRAs and other retirement benefits), and then distribute them to the trust beneficiaries as you have instructed.

9. Can I be my own trustee?
No. Not if you want the tax advantages we've explained. Some people name their spouse and/or adult children as trustee(s), but often they don't have enough time or experience. Many people choose a corporate trustee (bank or trust company) because they are experienced with these trusts. A corporate trustee will make sure the trust is properly administered and the insurance premiums promptly paid.

10. Why not just name someone else as owner of my insurance policy?
If someone else, like your spouse or adult child, owns a policy on your life and dies first, the cash/termination value will be in his/her taxable estate. That doesn't help much.

But, more importantly, if someone else owns the policy, you lose control. This person could change the beneficiary, take the cash value, or even cancel the policy, leaving you with no insurance. You may trust this person now, but you could have problems later on. The policy could even be garnished to help satisfy the other person's creditors. An insurance trust is safer; it lets you reduce estate taxes and keep control.

11. How does an insurance trust give me control?
With an insurance trust, your trust owns the policy. The trustee you select must follow the instructions you put in your trust. And with your insurance trust as beneficiary of the policies, you will even have more control over the proceeds.

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