Life
Insurance Trusts
What
is a Life Insurance Trust?
A life insurance trust is a trust that is set up for the
purpose of owning a life insurance policy. If the insured
is the owner of the policy, the proceeds of the policy
will be subject to estate tax when he dies. But if he
transfers ownership to a life insurance trust, the proceeds
will be completely free of estate tax. (The proceeds will
be exempt from income tax either way.)
Given the current estate tax rate of 45%, a life insurance
trust can save hundreds of thousands of dollars in estate
taxes. However, there are several drawbacks to
such an arrangement:
1.
You can't change the beneficiary of the policy.
The insured must give up the right to change the beneficiary
of the policy (the trust itself will be the beneficiary).
The trustee alone has that right, and the insured cannot
serve as trustee of his own life insurance trust. Of
course, the insured will designate the beneficiaries
of the trust (for example, his children). But because
this designation cannot be changed after the life insurance
trust has been set up, the insured will lack the flexibility
to deal with changed family circumstances with this
particular policy.
2. You can't borrow from the policy.
The insured can no longer borrow against the policy.
If the trust allows him to borrow against the policy,
he will be deemed to be an owner of the policy for estate
tax purposes.
3. You can't transfer an existing policy to
the trust -- unless you live for at least 3 more years.
If the insured transfers an existing policy to a life
insurance trust and dies within the next three years,
he will be treated as the owner of the policy and it
will be taxed in his estate. Even if he survives another
three years, he will have made a taxable gift in the
amount of the cash value of the policy (of course, this
is usually preferable to having the entire face value
subjected to estate taxes). If the life insurance trust
takes out a new policy on the insured's life, however,
the insured will never be deemed to own the policy.
Furthermore, no cash value will have built up yet, so
no taxable gift will be made.
4. The life insurance trust must be irrevocable.
Once you set up and fund the trust, you cannot get the
policy back. If you become uninsurable, you will be
committed to this trust as your only life insurance.
5. Premium payments may use up your estate tax
exemption.
If the policy has not yet endowed, you must find a way
to pay the premiums without using up your estate and
gift tax exemption. If you transfer securities to the
trust so that the trustee will have income with which
to pay the premiums, the full value of the securities
will be a taxable gift. If you transfer cash to the
trust each year to pay the premiums, each transfer will
be a taxable gift. However, you may be able to exempt
these premium payments from gift or estate taxes by
setting the life insurance trust up as a Crummey Trust.
Then each premium payment can be sheltered by your annual
gift tax exclusion, which is $12,000 (indexed for inflation)
per trust beneficiary.
6. You must find or hire a trustee.
The insured cannot serve as trustee of the life insurance
trust. That means that he will have to find or hire
a third party trustee. However, many banks and trust
companies offer reduced fees for life insurance trusts
because they involve essentially no investing decisions.
Despite these drawbacks, many people find that the tax
saving potential of a life insurance trust is worth
the cost and hassle. It allows you to remove from your
estate a significant asset that you are unlikely to
want access to during your life. And it ensures that
the life insurance proceeds go 100% to the beneficiaries,
not the federal government.
At
Penney and Associates, we are committed to providing
the best possible service so your
law related needs are handled with the utmost
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