Wednesday, January 07, 2009
Life Insurance Trusts
Many people say that life insurance benefits are tax free, but this not entirely true. There are a few levels of taxation to consider when speaking about taxes. Life insurance benefits are income tax free, but they are not estate tax free.
One strategy to pass a life insurance benefit estate tax free to one’s heirs is to place the life insurance policy into an irrevocable life insurance trust (ILIT). An irrevocable life insurance trust keeps the death benefits outside of a person’s estate so that they are not subject to estate settlement costs, income taxes, or estate taxes.
Since the trust is considered the owner of the life insurance upon death, the life insurance is excluded from the decedent’s gross estate unless death occurs within three years of the transfer. In that case, the entire value of the policy is brought back into the decedent’s estate for federal estate tax purposes. This three year look back period can be planned for by purchasing a new policy or a rider onto an existing policy if needed.
Whenever a trust is created, it must be determined whether the trust will be revocable or irrevocable. A revocable trust can be changed or even revoked by the Trustor (the person creating the trust) at any time. An irrevocable trust, however, cannot be changed. The assets placed into this type of trust must remain there. Beneficiaries cannot be added or deleted. And the only way to change the trustee is for that person to die or agree to resign.
Revocable trusts are flexible, but do not offer the tax benefits that an irrevocable trust can provide. In an irrevocable trust, the trust property is not calculated as part of the decedent’s estate, and is therefore not subject to estate taxes.
One disadvantage of an irrevocable trust is that it is well, irrevocable. Once the trust is established, it cannot be changed, except in a few specific circumstances, without court intervention.
When thinking about an irrevocable life insurance trust, there are many important considerations to make (i.e. who is an appropriate trustee, how are the insurance premiums to be paid, what type of policy is appropriate for an ILIT, should a Trust Protector be named, and how distributions after death should be made). Please discuss your estate planning objectives with an experienced attorney to decide if this method is right for your situation.