Make sure you keep in mind that this answer is supplied inside the spirit of public education, not as legal suggestions. In case you require legal guidance for a certain scenario, it is best to consult an attorney.
A life insurance trust is really a trust that’s setup for the purpose of buying a life insurance policy. If the insured will be the owner of the policy, the profits of one’s policy is going to be at the mercy of estate tax when he or she dies. However, when he moves ownership to a life insurance trust, the income will probably be entirely free of estate tax. (The takings might be exempt from income tax either way.)
Given the present estate tax rate of 35%, a life insurance trust can help to save tens of thousands of revenue in estate taxes. Nonetheless, you will discover several drawbacks to such an agreement:
1. You cannot alter the beneficiary of one’s policy.
The insured ought to let go of to alter the beneficiary of the policy (the trust itself will probably be the beneficiary). The trustee alone has that perfect, and the insured cannot serve as trustee of his own life insurance trust. Of course, the insured will select the beneficiaries of your trust (for example, his kids). But simply because this designation cannot be changed immediately after the life insurance trust has been constructed, the insured will lack the flexibility to deal with changed family members predicaments with this particular policy.
2. You simply can’t borrow from the policy.
The insured is unable to borrow from the policy. If the trust makes it possible for him to borrow against the policy, he will be deemed to be an owner of the policy for estate tax purposes.
3. You cannot transfer an existing policy to the trust — until you live for a minimum of three more years.
If the insured transfers a preexisting policy to a life insurance trust and dies inside the next 3 years, he will probably be regarded as the owner of the policy and it will be taxed in his estate. Even if he survives an additional 3 years, he will have made a taxable gift in the amount of the money value of the policy (of course, this really is typically better to having the entire face value subjected to estate taxes). If the life insurance trust takes out a new policy on the insured’s life, on the other hand, the insured will never be deemed to own the policy. Furthermore, no cash value will have built up yet, so no taxable gift will be created.
4. The life insurance trust must be irrevocable.
As soon as you set up and fund the trust, you can’t get the policy back. Should you become uninsurable, you may be committed to this trust as your only life insurance.
5. Premium payments may possibly use up your estate tax exemption.
If the policy has not yet endowed, you have to uncover a way to pay the premiums with out making use of up your estate and gift tax exemption. When you transfer securities to the trust to ensure that the trustee will have income with which to pay the premiums, the full value of your securities will probably be a taxable gift. In case you transfer money to the trust each year to pay the premiums, every transfer will probably be a taxable gift. Even so, you may be able to exempt these premium payments from gift or estate taxes by setting the life insurance trust up as a Crummey Trust (see the FAQ on Crummey Trusts). Then each and every premium payment could be sheltered by your annual gift tax exclusion, which is $13,000 (indexed for inflation) per trust beneficiary.
6. You should locate or hire a trustee.
The insured cannot serve as trustee of the life insurance trust. That indicates that he will have to come across or hire a third party trustee. Nonetheless, quite a few banks and trust organizations offer you decreased fees for life insurance trusts since they involve basically no investing decisions.
In spite of these drawbacks, a lot of people locate that the tax saving possible of a life insurance trust is worth the cost and hassle. It allows you to remove from your estate a significant asset that you might be unlikely to want access to in the course of your life. And it ensures that the life insurance profits go 100% to the beneficiaries, not the federal government.