ESTATE PLANNING BENEFITS OF IRREVOCABLE LIFE INSURANCE TRUST
Trusts are an efficient estate planning instrument for generating wealth and protecting assets for loved ones without risking the loss of assets to creditors in the event of incapacity or death. Trusts can provide substantial tax advantages, such as the opportunity to gift assets many times while preserving their value in the trust. Our specialists can advise you on the form of irrevocable life insurance trust that best meets your requirements.
Almost all adults you know have life insurance, either through their employer or individually. A life insurance irrevocable trust is a specific sort of trust that can be used for estate planning. An irrevocable life insurance trust (ILIT) allows you to handle your life insurance policy’s assets outside of probate. The irony is that most people with life insurance plans believe – whether correctly or incorrectly – that the payouts from these policies are tax-free.
TAX CONSEQUENCES OF LIFE INSURANCE
The death benefits of life insurance policies, when paid to the beneficiaries, are exempt from federal income tax. However, the total death benefit is typically included in the IRS’s taxable estate computation. When the recipients get the monies straight from the insurance company, no income tax is withheld, and the full amount is disbursed as intended. Nonetheless, the decedent’s estate executor will file two distinct federal tax returns. One will be the final federal income tax return, but the other is of greater relevance to this debate.
This second federal tax return is the Gift and Estate Tax Return. It will consider the total value of all the estate’s assets, including tools in the garage, paintings on the wall, coin collections, and financial accounts of every type (no matter where they are located), as well as any real estate, retirement assets, and life insurance held in the ‘Incorrect’ manner.
Given the substantial amount of money paid out annually in life insurance policy death benefits, it is surprising that this issue is not widely known. Today, the actual cost of death benefits is cheaper than ever, and the number of people establishing term insurance plans is astounding. Indeed, life insurance produces wealth for the following generation and covers the insured’s bills and obligations. Some of the wealthiest and most prominent families in America have utilized Life Insurance Trusts extensively. It goes as follows:
- Grandfather establishes a Life Insurance Trust and funds it with a $1 million insurance on both grandparents’ lives.
- Dad and/or Mom (Grandfather’s adult grandchildren) establish a separate Life Insurance Trust for the benefit of their children. Since Dad and/or Mom are younger and healthier than Grandparents, obtaining higher life insurance death benefits at a lesser price is possible. They decided to have separate $2,000,000 policies held by separate Life Insurance Trusts.
- The adult child (about age 40) establishes two distinct policies owned by a separate Life Insurance Trust. One is for $3,000,000 and was established with his spouse as the trust beneficiary. The other insurance is for $3 million and is owned by a separate Life Insurance Trust; it covers both the Adult Child and the Spouse.
- This article explicitly addresses the Life Insurance Trust for two reasons:
- to address the tax issue related to safeguarding the whole worth of the estate and
- Discuss how Life Insurance Trusts can be utilized for lawsuit and divorce protection.
PROPERTY TAX APPLICATIONS
There are two life insurance Estate Tax applications.
First, suppose the estate’s total value is sufficient to trigger an Estate Tax. In that case, a policy or policies maintained in an irrevocable life insurance trust outside the estate can pay out to the trust and be used by the decedent’s survivors to pay any taxes on the Taxable Estate.
Second, if the Taxable Estate includes life insurance, the policies can be removed from the Estate and ownership transferred to a Life Insurance Trust outside the Estate. There are guidelines (such as the “three-year rule”) to adhere to. However, with careful planning and sound advice, you can relocate the policies outside your Estate and hold them such that the payout is neither subject to income tax nor estate tax.
ASSET PROTECTION FEATURES
When financed with cash value Life Insurance policies or other assets such as mutual funds, cash, certificates of deposit, etc., the assets under an irrevocable Life Insurance Trust are beyond the grasp of our creditors and, depending on the beneficiaries, beyond the reach of a divorce court. The irrevocable gifts you make to the policy remove them from your estate, making them inaccessible in divorce or lawsuit.
