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By John M. Bigler This months article will focus on an estate planning tool, the life insurance trust, which has become popular for individuals and spouses who may be faced with the prospect of significant federal estate taxes on their death. The idea of the trust is to purchase a life insurance policy whose benefits, payable on death, will be used to offset the estate taxes that would be due at the time of death. In this strategy, an insurance policy is placed in an irrevocable trust. If properly arranged, the trust keeps the policy out of the taxable estate and allows the proceeds to pass on free of federal or state estate taxes.
As an alternative to simply transferring the ownership of a policy to someone else, many people are considering setting up a life insurance trust. In order for he trust to be effective, the insured or grantor of the trust must not possess any incidence of ownership in the insurance policy. Therefore, the insured cannot have power to change a beneficiary, to surrender or cancel a policy, to borrow against the policy, to receive dividends, to convert the policy or any rights to receive proceeds exceeding five percent of the policy. Retention of any of these rights will cause the insurance proceeds to be included in the grantor's gross estate and defeat the purpose of the trust. However, if an irrevocable insurance trust has all the incidence of ownership, the insured has given up control and the proceeds of the policy included in the trust will not be included in the grantor's estate.
Naturally, this would be a very unwise decision on the part of the beneficiaries as there would then be no money to pay the premium. A simple way to avoid the possibility of removal of the premium payments is to simply provide in a will that any beneficiary that takes such an action will be cut out as beneficiary. There are many advantages of a properly drafted life insurance trust. Since there's no incidence of ownership retained by the grantor, the insurance proceeds are kept out of the estate for federal and state tax purposes. Plus, the life insurance proceeds become available to pay estate taxes without adding value to the taxable estate. This is especially helpful where assets in the estate are non-liquid. The trust can provide the trustee with a right to purchase assets or lend money to the estate. Also, an insured may not want his/her spouse or children to receive money outright, and the trust can be set up in such a way that the trustee will be responsible for managing funds beyond the death of the insured. Other benefits include avoiding debts of either the deceased or beneficiaries because the assets do not belong to either one but rather are payable to the trust. Also, the administration of the trust does not require probate. All in all, if the trust is drawn properly, it's a useful estate planning tool in almost all cases. Naturally, there may be some people not eligible for insurance either because of age, medical condition or cost. Also, there will be those who will be comfortable simply having another individual in the family be the owner of the policy. However, for many individuals the life insurance trust can be an ideal estate planning tool. Reprinted with permission of the Suffolk Times © 1999 [ Contact Us ] [ Guestbook ] [ Email ]  The Law Offices of John M. Bigler, Attorney At Law 1421 Wantagh Avenue, Wantagh, New York 11793-2206 1-888-ELDER-LAW · 516-409-6565 · Fax: 516-409-6522 E-Mail: info@biglerlaw.com · Web Site: www.biglerlaw.com |
Typically, most individuals hold a life insurance policy in their own name as owner. On death, the proceeds of the life insurance policy are considered part of that person's gross taxable estate and result in a larger estate tax to be paid. As we've discussed in past articles, the current federal estate tax exemption is $625,000 and rising up to $1,000,000 in the year 2006. For estate over that amount, federal estate taxes are levied and can be as high as 55 percent of the excess amount depending on the value of the estate. However, if someone else were the owner of the life insurance policy, the proceeds form the policy would not be included in the insured's estate and could be used for a number of purposes, one of which would be to pay the estate taxes.
One problem in transferring insurance into the trust is that if an insurance policy purchased by the insured is gifted within three years of the death of the insured, those proceeds are included in the estate once again. The way to avoid the three-year rule is to have the trust purchase the life insurance policy in the first instance. The funds to pay the premium on an annual basis can be transferred to the trust by the grantor of the trust. In order to take advantage of the annual $10,000 gift exclusion, the grantor will pay the premium to the trust but the trust will allow each of the beneficiaries of the trust, typically children, to remove the premium each year should they wish.