Irrevocable Life Insurance Trust
Life insurance has become a frequently used tool in estate
planning. Most individuals are familiar with it and utilize it due to its common nature.
But the effects of using life insurance as an estate planning tool really are not that
simplistic. Gone are the days when the insured being the owner is the norm - there are now
dozens of advantages and disadvantages to using life insurance, depending on who (or what)
owns the policy. Most of you are aware of the fact that if you own a life insurance policy
of which you are the insured, the death benefits payable upon your death are includible in
your estate for estate tax purposes. Whether or not the death value will be taxed depends
on whom you have named as the beneficiary of that policy. If you have named your spouse as
the beneficiary, the unlimited marital deduction will prevent the proceeds from being
taxed at your death. Nevertheless, if those proceeds remain in the estate of the spouse,
they will be included in the spouses estate upon death. The key to taxation of life
insurance proceeds revolves around the ownership of the policy. The irrevocable trust is
one technique utilized to address the issue of ownership.
An irrevocable trust is just that, irrevocable. Once an
individual creates such a trust, the terms of the trust contract can not be changed. As
such, the individual gives up all control and capability of management over any assets
owned by such a trust. Therefore, the Internal Revenue Service recognizes the fact that
under such a scenario, the assets included in this type of trust cannot be included in the
estate of the individual for estate tax purposes.
When an individual creates an irrevocable trust to hold
the ownership of a life insurance policy, the policy proceeds are removed from the gross
estates of both the insured and his or her spouse for estate tax purposes, assuming there
is no direct policy transfer by the insured or the insured outlives any such transfer by
three years. The insureds spouse can and normally does have an interest in the trust
after the insureds death, as long as the policy is not a survivorship policy and he
or she is not given an estate tax sensitive power or interest in the trust. For decedents
dying after 1981, this is the only way to do more than defer the tax and give the spouse
any benefit from the proceeds.
The general advantages of naming a trust as the
beneficiary are as follows:
- protection of the beneficiaries against creditors and
- investment management of the process
- avoidance of the generation-skipping transfer tax
altogether, if the trust can be arranged to be effectively exempt from the tax by
application of the insureds GST exemption (and that of the spouse) or by relying on
the non-taxable gift exception to the GST.
The proceeds can be made available to the executor to pay
costs and taxes of the insureds estate by a loan, purchase of assets or direct
payment. Each of these techniques has its possible disadvantages; perhaps, the purchase of
assets concept makes the most sense - assuming a stepped-up basis for the assets at death.
Another advantage is that is solves the problem of the
primary beneficiarys death before the insureds. It also avoids the problem of
the possible incompetence of the policy owner, the potential frustration of the
insureds plan by the owner during the insureds life; and the problems of
multiple and/or potentially legally incompetent owners.
Under state law, naming a trust as the policy owner
provides creditor protection for the policy during the insureds life. It also can
provide creditor and spousal protection for the beneficiaries.
The policy, although beyond the insureds direct
control, is in the hands of the trustee chosen by the insured to carry out the terms of a
trust created by the insured. Therefore, this is a fairly - but by no means totally -
comfortable arrangement for most insureds once the decision has been made to give up
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