Life insurance trusts offer discounts on estate tax

Now that we have a more permanent estate and gift tax exemption ($5.25 million per person, or $10.5 million per married couple), planning your estate is a bit easier.  If estate taxes are still an issue for you, using an Irrevocable Life Insurance Trust (ILIT) to purchase new policies or hold your existing life insurance policies is a fantastic tool for most people.

An ILIT offers the opportunity of minimizing or avoiding taxes in several estates. It is typically a trust for the benefit of your spouse and/or children. A policy that is placed in an ILIT is considered owned by the trust; therefore, once in an ILIT, you will not have the power to change or cancel the life insurance policy.  However, the benefit is that the life insurance proceeds from a policy owned by trust will not be subject to any federal estate tax, while any policies owned directly by you are taxed (up to 40%).

Even when the life insurance policy is payable to a surviving spouse, while the proceeds are not taxable to your estate, due to the unlimited marital deduction, they become part of the surviving spouse’s taxable estate and face estate taxes then.

With appropriate planning, the trust can be established without gift and estate tax consequences.  Congress has also granted favored tax status upon life insurance that no other investment product enjoys. Proceeds of life insurance pay to the beneficiaries of the life insurance absolutely free of income tax.

If an existing policy is contributed to the ILIT with nothing given in return, the grantor must survive at least three years after making the transfer, if the transferred property would otherwise be included in his or her gross estate. After contribution of the policy to the ILIT, the ILIT is the owner of the policy, and the trustee is responsible for paying insurance premiums.

Because an ILIT is an irrevocable trust, all contributions of property to the ILIT are taxable gifts–you can still take advantage of your yearly $14,000 gift tax exclusion when making these gifts.   It is essential that the trustee keep accurate records of contributions to the trust and the sending out of “Crummey” letters. Good practice is to send a letter that allows the beneficiary to sign one of two options: either the beneficiary wants to exercise the withdrawal right, or the beneficiary wants to waive his right to withdraw.  Attorneys and private trustees often offer this service to ensure the trust rules are followed and thus the life insurance remains outside your taxable estate.

How can I help?

Call Christopher B. Johnson at (888) 503-7615 or by our contact form with any questions regarding life insurance trusts, or living trusts, special needs trusts, wills or probate.  We also handle probate litigation, including financial elder abuse, physical elder abuse, trust contests, will contests, trustee removal and trustee’s breach of fiduciary duty, in Los Angeles, San Bernardino and Riverside counties.