Life Insurance Trust Information
What does a Life Insurance Trust do?
A non-revocable Life Insurance Trust reduces or eliminates estate taxes, resulting in more of your estate being distributed to your beneficiaries and less of your estate being disbursed for estate taxes. A Life Insurance Trust also gives you more control over the money paid by the insurance company to your beneficiaries upon your death (“insurance proceeds”), a benefit that will continue even when “death taxes” are repealed.
What are estate taxes?
Under current tax laws, if the net value of your estate when you die is more than $1 million in 2002, federal estate taxes (starting at 37%) must be paid before your estate can be distributed to your Beneficiaries. (The exemption is scheduled to increase to, $1,500,000 in 2004, $2,000,000 in 2006, $3,500,000 in 2009, with repeal of the federal tax by 2010. Congress must extend the law beyond 2010 for changes and/or repeal to continue beyond 2010.) Estate plans should include planning for the possibility that the “estate tax repeal” will not be extended.
Estate taxes must be paid in cash, usually within nine months after death, and your Beneficiaries could be required to sell assets (such as, real estate, family-owned businesses and farms) to pay estate taxes. (Probate expenses and final income taxes on your income in the year that you die are not “estate taxes”.)
What is the net value of an estate?
The net value of your estate is the total value of what you own, including life insurance, IRA and other retirement benefits, investments, bank accounts, personal property and your home, reduced by the total of your debts. Although life insurance proceeds are not included in a “probate estate”, if you die while holding “incidents of ownership” in a life insurance policy on your life, the death benefit proceeds will be included in your taxable estate. “Incidents of ownership” include the power to name the Beneficiary, borrow against the insurance policy, assign the proceeds, revoke an assignment, or cancel the policy.
How does an Insurance Trust help?
The Insurance Trust owns your insurance policies. Since you will not personally own the insurance policy, the proceeds will not be included in your net estate. Since the insurance proceeds will not be included in your net estate, your Beneficiaries receive more because the insurance proceeds will not be subject to estate taxes.
Who can benefit from an Insurance Trust?
If you are single and the value of your net estate (including your life insurance) is more than $1 million, or if you are married and the value of your total net estate is more than $2 million, you should consider an Insurance Trust to reduce your estate taxes.
If you are married with a combined net estate of $2.4 million, $400,000 of which is life insurance, with tax planning in your Will or Trust, in 2002 you can protect up to $2 million from estate taxes. Without an Insurance Trust, your estate would have to pay $153,000 in estate taxes on the additional $400,000. Whereas, with an Insurance Trust, the $400,000 insurance proceeds would not be included in your estate, and your Beneficiaries will receive $153,000 more because the insurance proceeds will not be subject to estate taxes.
What if my estate is larger than this?
If your estate would be liable for estate taxes even if your insurance is held in an Insurance Trust, the Insurance Trust can buy additional life insurance to provide cash to pay the estate taxes.
Remember that if the Trust owns the life insurance, the insurance proceeds, which will not be subject to probate or income taxes, will also not be subject to estate taxes. Life insurance proceeds will be available immediately, and your Beneficiaries will not be required to sell estate assets to pay estate taxes. Life insurance can be an inexpensive way to pay estate taxes and other expenses, enhancing the value of your estate available to your Beneficiaries.
How does an Insurance Trust work?
An Insurance Trust is created by you as the Grantor (also called Creator, Settlor, or Trustor), naming an independent Trustee to manage the Trust for the benefit of the Trust Beneficiaries who will receive the Trust assets when you die. You give money to the Trust, and the Trustee purchases an insurance policy with you as the insured and the Trust as the owner and beneficiary of the policy. After your death, the Trustee will collect the insurance proceeds and distribute the money as you have instructed in your trust agreement.
Can I be my own Trustee?
Not if you want the tax advantages. The Trustee should be someone you trust, who will faithfully manage the Insurance Trust according to your trust agreement. Your adult child, a sibling, or a friend or associate can be named as Trustee(s). A professional Trustee or a Corporate Trustee (a bank or trust company), because of their experience with Insurance Trusts, will assure that the Trust is properly administered and the insurance premiums promptly paid.
Why not just have someone else be the owner of my insurance policy?
If someone else (such as your spouse or adult child) owns an insurance policy on your life and that person dies first, the cash (or termination) value of the policy will be included in that personıs taxable estate. If someone else owns the policy, you have surrendered control to that person who could name another Beneficiary, take the cash value, or even cancel the policy, leaving you with no insurance. An Insurance Trust is safer because the Trustee is legally obligated to manage the Trust according to your trust agreement.
How does an Insurance Trust give me control?
With an Insurance Trust, your Trust owns the policy. No one can change your Trust. The Trustee that you select must follow the instructions that you included in your trust agreement. Since your Insurance Trust will be the Beneficiary of the insurance proceeds, the proceeds must be distributed according to your desires as described in your trust agreement.
Your trust agreement could require that the Trustee use the proceeds to purchase assets from your estate or Revocable Living Trust, providing cash to pay expenses. Your trust agreement could require that the Trustee give your spouse a lifetime income, keeping the insurance proceeds out of both of your estates. Your trust agreement could require that the Trustee give the Beneficiaries of your Insurance Trust periodic payments.
What are the benefits of having the Trust be the Beneficiary of an insurance policy?
You may have carefully planned who will inherit your estate, but most people do not plan how life insurance proceeds are to be applied, consistent with estate planning goals.
If your spouse (or someone else) is the Beneficiary of the insurance policy and you die first, when that Beneficiary dies, the insurance proceeds will be included in that Beneficiaryıs taxable estate, creating a tax problem. If your children are Beneficiaries of the policy, they will receive the insurance proceeds upon your death, and you will have surrendered your ability to control how the insurance proceeds are to be used. Remember that the reason for buying life insurance is to provide money for some specific purpose.
If you name an individual as the Beneficiary of an insurance policy and that person is incapacitated or incompetent when you die, a court could take control of the proceeds, because insurance companies may require court supervision before they will pay the insurance proceeds to an incapacitated or incompetent person. But if your Trust is the Beneficiary of the insurance policy, the Trustee can use the proceeds to provide for this incapacitated or incompetent person, without court interference (so long as the Trustee manages the Trust according to your trust agreement).
Who can be Beneficiaries of the Trust?
You can name your spouse, your child(ren), or any person or organization you want.
Where does the Trustee obtain the money to purchase a new insurance policy?
It is very important that you will not pay the insurance premiums. Instead, you give money to the Trustee, “in trust”. That money is designated as a gift for the Trust Beneficiaries. The Trustee notifies each Trust Beneficiary that a gift has been received on his or her behalf and, unless he or she elects to receive the gift now; the Trustee will invest the funds by paying the premium on the insurance policy. (Of course, the Beneficiaries must understand not to take the gift now.)
When you transfer money to the Trustee, that money could be subject to a gift tax, but each year, you can gift up to $10,000 to each Beneficiary of your Trust with no gift tax. (You and your spouse together can gift up to $20,000 per Beneficiary.) Instead of making the gift directly to the Beneficiaries, you give the gift, “in trust”, to your Trustee, and your Trustee ultimately pays the insurance premium.
Can I transfer my existing policies to an Insurance Trust?
Yes, but if you die within three years after the date of the transfer, the transfer could be considered a taxable gift, and the transfer could be considered invalid by the IRS and the insurance could be included in your taxable estate.
Can I make changes to the Trust?
No, because an Insurance Trust is non-revocable. Read your trust agreement carefully to be sure that it is exactly what you want before you sign.
When should I set up an Insurance Trust?
Now. People wait until they are over 50 or 60 because they are uncertain about family relationships. Relationships always change. There is no magic age. If things change, you will not have to make the annual gifts, although that could seriously affect the intentions of your Insurance Trust. If things change, instead of adding more insurance to your Insurance Trust, you can create a new insurance trust to meet your new concerns. If you wait too long, you could become uninsurable. Remember that if you transfer existing policies to an Insurance Trust, you must live at least three years after the transfer or your estate will not receive the desired tax benefit.
Should I seek professional assistance?
Yes. If you think an Insurance Trust would be of value to you and your family, talk with an estate planning attorney who has experience with these Trusts.
