In planning for your estate, you may have heard or researched the question of whether to place the life insurance you have or intend to purchase into a trust. While the policy itself is clearly to provide for the future financial needs of your family should you die, why would you put life insurance in a trust? Well the motivation for people put their insurance in an irrevocable trust comes from a number of related reasons:
1) Avoiding Excessive Inheritance Tax
Because your primary goal in estate planning is to pass on your wealth to future generations of your family, and not necessarily to the federal government. By creating an insurance policy that is owned by an irrevocable trust, (meaning a trust not owned or accessible by you) it is no longer part of your estate for estate tax purposes. If you believe your estate is a potential target for the estate or inheritance tax, the life insurance trust can be a valuable tool.
2) To Ensure that Proceeds are Available and Used for Estate Administration
While the above goal of avoiding the inheritance task could simply be achieved by gifting the entire life insurance policy to the intended beneficiaries, an element of control would be sacrificed. A beneficiary might, for example, use the funds for a diamond necklace instead of a much needed attorney. At the very least, a trustee can ensure that money is needed for the potentially costly administration of a trust.
3) To Provide for Liquidity in a Complex Estate
If the majority of an estate’s value stems from an asset like a business, then the costs of selling that business, paying taxes on the sale, and then distributing the proceeds to beneficiaries can be very difficult to cover. In this situation the Trustee can use the irrevocable life insurance trust to purchase assets out of that business or other complex estate, providing for some cash flow to administer to those needed tasks.
4) Leverage for the Donor’s Annual Gift-Tax Exclusions
Because each person is limited from giving away beyond a certain amount of money each year before facing potential estate or gift tax liability (as of 2011 around $13,000 per year), the irrevocable life insurance trust offers a reasonable alternative. By contributing some amount below the gift threshold towards the life insurance premium each year, the value he effectively passes on to the beneficiaries when the policy is paid will be much larger than the combined amount of his annual gifts.
5) To Ensure that the Maximum Amount of Proceeds are Possible for Estate Administration
The overall purpose and effect of a properly created irrevocable life insurance trust is to make sure that all the fees and expenses necessary to administer a trust are not themselves taxed. You should always make sure you have experienced legal counsel to structure this asset in a way that will guarantee that the funds you set aside for your family will not incur any additional burdens when you’re no longer available to help them yourself.
In conclusion, the irrevocable life insurance trust is an invaluable tool for the administration of many estates. In order to set one up properly, hiring a reputable local estate planning attorney that is familiar with the laws and regulations of the federal and relevant state legal and tax systems is highly recommended.
