Life Insurance Trust
The estate tax is not just for rich families. In fact, the rich are more likely to plan then the unwary middle class family. If you have a modest estate but purchased a life insurance policy, you could subject your family to a surprise estate tax bill that could have been avoidable with planning. Life insurance proceeds are not subject to the federal income tax but are part of your taxable estate when it comes to the estate tax.
A solution to this problem is to create an irrevocable trust 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 is how this kind of 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 work to protect your family from an unpleasant surprise.