This article has been provided in the spirit of public education and should not be construed as legal advice. If you are in need of legal advice to handle a particular situation you should consult an attorney.
In the explanation of, what is a life insurance trust, we will assume that you are a policy holder of a $500,000 insurance policy. We will look into what happens if you die with or without a life insurance trust. We will also look into the differences of both funded and unfunded trusts, and there respective benefits and disadvantages. After we have covered all of the bases regarding a life insurance trust you will be much more informed about one of the many ways to protect your loved ones.
First let’s look at what happens when you die without a trust. Your life insurance policy then becomes a portion of your estate and is then subjected to estate taxes. That is a $175,000 tax bill that can be avoided simply by having a life insurance trust. This means a life insurance trust can have a huge tax benefit for your loved ones.
Life insurance trusts can be either funded or unfunded. A funded trust means that the insured pays for the life insurance premiums by transferring securities into the trust to be used for the payment of premiums. Unfunded life insurance trusts are paid through one time gifts to the trustee to pay the premiums. The payments will be taxed as gifts from the insured to the trustee.
It is possible to circumvent the gift tax with a Crummey Trust. In this case the money used to pay the premiums (up to $13,000 per calendar year) can be put into a trust where the beneficiary is a child of the person covered by the insurance policy. The money placed into the trust is available to be spent by the child for 30 days. If they elect not to spend the money it is held in the trust until the child reaches a previously set age that allows them full access to the entire trust. By doing so the trust gets around the present interest rule that only allows gifts to go untaxed if they are to be used immediately.
A life insurance trust is irrevocable and is not amendable. To avoid estate taxes the insured cannot also be the policy owner. In most cases the trustee is setup as the owner from the beginning of the policy. An existing policy can be transferred to the trustee, but the person covered must not die within three years of the transfer or the I.R.S. will not accept the validity of the transfer.
We have seen some benefits of having a life insurance trust. Now let’s look at a few of the disadvantages. You will not be able to change the beneficiary of a life insurance policy held in the trust if family circumstances change. You cannot borrow against the policy without the policy being deemed part of your estate for estate tax purposes. The trust will be irrevocable. If you become uninsurable later on in life you cannot amend this policy. You must hire a trustee or find someone to appoint as the trustee. However, in most cases you can find a bank or trust company willing to act as the trustee for a very reduced rate because life insurance trusts don’t require investment advice and don’t need to be acted upon until the event of your death.
Even with the drawbacks a life insurance trust offers plenty of benefits including ensuring that 100% of your life insurance proceeds go to your beneficiaries. If your estate falls within the threshold of being taxed by the federal government, setting up a life insurance trust is one of the most important decisions you can make for your heirs.
Las Vegas attorneys Anthony L. Barney and Tiffany S. Barney can help you navigate the many variables that need to be set in stone in order to ensure your life insurance trust will protect your beneficiaries from costly taxes and heartaches later on.
Find more tips on cost saving estate planning techniques here. Also, access our client resources page for more tips on keeping your money in your estate.