Few people realize that, even though they may have a modest
estate, their families may owe hundreds of thousands of dollars in estate taxes
because they own a life insurance policy with a substantial death benefit. This
is so because life insurance proceeds, while not subject to federal income tax,
are considered part of your taxable estate and are subject to federal estate
tax.
The solution to this problem is to create an irrevocable life
insurance trust (sometimes referred to as an "ILIT") that will own
the policy and receive the policy proceeds on your death. A properly drafted
life insurance trust keeps the insurance proceeds from being taxed in your
estate as well as in the estate of your surviving spouse. It also protects the
trust beneficiaries from their own "excesses," against their
creditors, and in the event of divorce. Moreover, the trust also provides
reliable management for the trust assets. Here's how the irrevocable life
insurance trust works.
You create an irrevocable life insurance trust to be the owner
and beneficiary of one or more life insurance policies on your life. You
contribute cash to the trust to be used by the trustee to make premium payments
on the life insurance policies. If the trust is properly drafted, the
contributions you make to the trust for premium payments will qualify for the
annual gift tax exclusion, so you won't have to pay gift tax on the
contributions.
The life insurance trust typically provides that, during your
lifetime, principal and income, in the trustee's discretion, may be paid or
applied to or for the benefit of your spouse and descendants. This allows
indirect access to the cash surrender value of the life insurance policies
owned by the trust, and permits the trust to be terminated if desired despite
its being irrevocable. On your death, the trust continues for the benefit of
your spouse during his or her lifetime. Your spouse is given certain beneficial
interests in the trust, such as the right to income, limited invasion rights,
and eligibility to receive principal. On the death of your spouse, the trust
assets are paid outright to, or held in further trust for the benefit of, your
descendants.
If you own a life insurance policy with a significant death
benefit, an irrevocable life insurance trust may be of substantial benefit to
you and your loved ones. Please contact us if
you would like to discuss this further.
