Life Insurance Trusts-Reduce Federal Estate Taxes and Provide for Your Family's Future When You Are Gone

Most people hear the word "trust" and have visions of complex legal instruments. However, they can be an invaluable component of the estate plan. With this said, it's important for us to start out with the basics.¹

A trust is essentially a legal arrangement where property is transferred to another party (known as a trustee) for the benefit of another person or entity, which is commonly known as the beneficiary.² A life insurance trust is a special type of trust that holds title to a life insurance policy. In many cases, the primary purpose of this trust is to help certain taxpayers reduce their federal estate tax burdens. In 2006-2008, federal estate taxes are imposed upon estates in excess of $2 million.

In the absence of a trust, any insurance policy that you own personally is included in your gross estate. As a result of this, the death benefits from the policy would be included in your estate and could be subject to federal estate taxes. On the other hand, by purchasing the life insurance policy through a trust, you can keep the death benefits out of your estate.³  This can potentially result in a significant tax savings.⁴

Notwithstanding the tax benefits of these arrangements, these trusts can also facilitate your estate planning in other ways too. For example, you might decide that the needs of your beneficiaries are better served by allowing an experienced trustee to manage the policy proceeds in the trust. In this situation, your trust's beneficiaries can receive the income generated from the proceeds when the trust receives it. Furthermore, the trust can reinvest the proceeds on behalf of your beneficiaries.

Unfortunately, not everyone is equipped to make sound investment decisions, especially those who are minors, disabled, or are not otherwise capable of managing money. These beneficiaries in particular would benefit from this sort of arrangement. Of course, the trust can also be structured in a manner that requires the policy proceeds to be distributed to the beneficiaries immediately, or when they reach a certain prescribed age.

Notwithstanding the potential planning benefits, a few cautionary planning points must be observed. First, to prevent the policy proceeds from being placed in your estate, the arrangement must be structured as an irrevocable trust. This means that the trust cannot be revoked once is funded. A small exception, however, might apply in the event that all beneficiaries were willing to agree to the revocation.

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¹ Much of the legal information presented in this article was provided by Bradford Updike, JD, CSA, whose an attorney employed by Securities America, Inc.

² http://www.wave.co.nz/~bsl/art2.htm , (2005) August 26, 2005

³ A life insurance trust can also be funded by transferring an existing policy to an irrevocable trust. However, the initial policy owner must live at least three years after the policy is transferred to the trust. If the previous owner fails to survive this 3-year period, then the policy is included in such owner's estate.

⁴ Christine J. Sylvester, http://willsandprobate.com/FAQ/life-instrust.htm (2005), (Aug. 27, 2005).
 Also, the trust grantor (i.e., the person who establishes the trust) cannot retain any incidents of ownership in the policy. This means that the grantor cannot change the policy's beneficiary. It is also commonly understood that the grantor should not serve as the trustee. Additionally, if the grantor borrows against the policy, then the grantor is considered the owner of the policy for federal estate tax purposes. As a result, the proceeds from the policy will be included in the grantor's estate and could be subject to the federal estate taxes .

⁵ Most of us realize that life insurance can be a great way to provide for our loved ones' future when we are gone. Additionally, by taking an additional planning step in having the policy owned by a trust, you are potentially maximizing all the benefits that a life insurance policy offers. However, you will need a trusted legal professional to make sure it is done right! Contact our office for a referral to an appropriate attorney.
   Note: life insurance qualification is subject to medical underwriting guidelines, which are based among other things, upon the insured's age and health. Insurance premiums, which represent the cost of the policy, can also vary depending upon the insured's age, health, and desired coverage limits. Sales commissions surrender fees and other policy charges can also apply to purchases of life insurance. Insurance guarantees are also subject to the claims-paying ability of the issuing company.

⁵ Christine J. Sylvester, http://willsandprobate.com/FAQ/life-ins-trust.htm  (2005).