Life Insurance Trusts
A life insurance trust is a way to provide for eventual estate tax. Here's how it works. You establish an irrevocable (mostly can't change it) trust for the benefit of your children, and contribute money to it. The trustee buys life insurance that is outside your taxable estate. So when you die (sorry), the life insurance pays off in the trust and the trustee has money to help pay your estate taxes. Actually such a trust may hold other assets as well, like securities and family LLC interests. This gets those other assets out of your taxable estate as well, and they can provide income in the trust to help pay the insurance premiums.
What is the difference between an irrevocable trust and a life insurance trust?
A life insurance trust is just one type of irrevocable trust.
Is a life insurance trust a type of gift trust?
Yes, a life insurance trust is a type of gift trust.
What can I give to a trust?
You can give almost any kind of asset to a trust. Some assets are better to give than others. For example, you may not want to place an asset that has a low tax basis in the trust. If you do, it won’t obtain a “stepped up” basis at your death which would have allowed your children to avoid capital gains. Consult with an attorney regarding the best types of assets to give to a trust.
Who should be the trustee of my life insurance trust?
Nearly any responsible person or corporate trustee can be the trustee of a life insurance trust. The person who establishes the trust cannot be the trustee.
What is the difference between a revocable and an irrevocable trust?
Trusts are legally enforceable arrangements that detail a property’s ownership and management. The main difference between a revocable and irrevocable trust turns on whether the creator of the trust, also known as the grantor, can change the arrangements detailed in the trust. In an irrevocable trust, the terms cannot be changed by the grantor once it has been created, while in a revocable trust the terms can be changed. Revocable trusts also allow a grantor to recover property back, even after it has been granted to an individual or entity, also known as a beneficiary.
What is an ILIT?
An Irrevocable Life Insurance Trust, also known as an ILIT, is a type of trust set up so that a beneficiary may own a life insurance policy. ILITs are created to create and/or own an insurance policy while the insured individual is alive. An ILIT is a type of irrevocable trust, meaning that once a grantor has placed the policy in ownership of the beneficiary, it cannot be changed nor can it be repossessed by the grantor unless ownership of the trust is relinquished to a trustee. A trustee is an individual given control of a trust with a legal obligation to administer the trust for the purposes specified by a grantor. A spouse or an adult child may still serve as a trustee of an ILIT, and anyone (other than the grantor or the grantor’s estate) can be named a beneficiary of an ILIT. At the time of passing, the insurance proceeds are deposited into the ILIT where they can then be distributed to the trust’s named beneficiaries.
What is the difference between the insured, the owner, and the beneficiary of a policy?
In a life insurance policy, the individual who is covered by the policy’s protections and on whose life it is measured is known as the “insured.” The policy “owner” is the individual who pays the premiums for the policy, who has the right to name the beneficiaries and, in some instances, has the right to make withdrawals or loans against a policy. A “beneficiary” is the individual who will receive the benefits or payments of the policy upon the insured’s passing. Insurance policies may have more than one named beneficiary and proceeds may be divided equally or in specific amounts for each of them depending on the type of policy. Transferring a life insurance policy to an irrevocable trust may help an individual avoid additional estate taxes, so long as the policy is transferred more than three years prior to an insured’s passing.
Is life insurance income? Is life insurance tax free?
Generally, life insurance is not considered income for taxation purposes. In cases where a life insurance policy is surrendered and its value exceeds that of what was paid into it, income taxes may be owed based on the increase in value. Additionally, the sale of certain types of insurance policies is considered taxable income. Depending on the value of an individual’s estate or policy, the income from the sale of the policy may be taxable.
What is the difference between term life insurance and whole life insurance?
There are several differences between term life insurance and whole life insurance. Term life insurance is generally easier and more affordable than whole life insurance, although it does become more expensive as the insured ages. Term insurance provides coverage within specific lengths of time and must be renewed before these are extended. The benefits of a term insurance are only paid when an insured passes away while under coverage. Furthermore, term insurance only provides death benefits.
With whole life insurance, a beneficiary still needs to be within a policy’s coverage to receive a death benefit, but the coverage spans the rest of an insured’s life, not a set term period. Additionally, when the value of the policy reaches a set amount, it can be borrowed or withdrawn. Because of these differences, whole life policies are significantly costlier than term insurance policies.