What Is Using Personal Life Insurance Trusts?
There are many situations where it makes sense either to transfer an existing insurance policy on your life into a trust or to have a trust purchase a new insurance policy on your life. There are two types of trusts that can be used for this purpose: an irrevocable life insurance trust or a revocable life insurance trust. As the name implies, an irrevocable trust is one that cannot be changed or revoked once it is created. You generally cannot change the trustee, you cannot change the beneficiaries or the terms of the trust, and you cannot remove the assets in the trust. A revocable trust is just the opposite in that you can change the trustee, add or remove beneficiaries, withdraw assets from the trust, and terminate the trust.
The most common type of trust used to hold a life insurance policy is an irrevocable trust. The main benefit to using an irrevocable life insurance trust is that the assets in the trust (i.e., the proceeds of the life insurance policy after you die) will not be included in your taxable estate at your death. As long as you do not retain any incidents of ownership in the life insurance policy, the proceeds should not be taxed in your estate. You may also want to use an irrevocable trust if your beneficiaries are minors or are irresponsible with money.
Another type of trust that can be used to hold a life insurance policy is a revocable trust. Unlike an irrevocable life insurance trust, the proceeds in a revocable trust will be included in your taxable estate. You may want to use a revocable insurance trust if your beneficiaries (usually your children) are minors or are irresponsible with money. Using a revocable trust allows you to have control over the management and disbursement of the assets until your death.
Irrevocable Life Insurance Trust
Life Insurance Proceeds Not Included In Taxable Estate
An irrevocable life insurance trust is the most widely used trust for insurance planning. Most people will use an irrevocable life insurance trust if they anticipate that their assets will be above the applicable exclusion amount. Because the trust is irrevocable (and as long as you do not retain any incidents of ownership in the policy), the proceeds from the insurance policy will not be included in your taxable estate at your death. Your beneficiaries will also not have to pay any income tax on the proceeds from the life insurance policy. For these two reasons, your beneficiaries may use the full proceeds from the life insurance policy to pay any federal estate tax that may otherwise be due on your estate. You may also use an irrevocable life insurance trust as a way to enhance (free of estate tax) the value of your estate.
Caution: If you transfer an existing life insurance policy into an irrevocable life insurance trust and then die within three years of the transfer, the proceeds from the life insurance will be pulled back into your taxable estate.
Cash Payments to Irrevocable Life Insurance Trust May Qualify for Annual Exclusion
If the beneficiaries of the irrevocable life insurance trust are given Crummey powers, transfers of cash into the trust (to purchase a life insurance policy) may qualify for the annual gift tax exclusion. To qualify for the annual exclusion, the donee must have a present interest in the gift (i.e., the right to presently use, enjoy, and possess the gift). A "Crummey" power is the right, exercisable by the beneficiaries of the trust for a certain length of time (usually 30 to 60 days) to withdraw any transfers made into the trust. As long as the beneficiaries are given these Crummey powers, they are considered to have a present interest in any transfers into the trust.
Use of Trust Gives You Control over Disposition of Money
Another reason to use a trust for your life insurance planning is if your beneficiaries are either too young or too irresponsible to purchase the life insurance policy or to handle the proceeds from the life insurance. Instead of setting up an irrevocable life insurance trust, you could simply make a direct gift of cash to your beneficiaries, which they could use to buy an insurance policy on your life. You could also directly transfer ownership of an existing insurance policy on your life to your children. As long as you do not retain any incidents of ownership in the policy for the three years prior to your death, the proceeds from the insurance policy will not be included in your taxable estate when you die.
However, with a direct gift of cash, there would be no guarantee that your beneficiaries would use the money to purchase an insurance policy on your life. Furthermore, you may not want your beneficiaries to have direct control over the proceeds of the policy when you die. By using a trust, you can appoint a trustee who will use any transfers into the trust to purchase an insurance policy on your life. Furthermore, you can stipulate in the trust how and when the funds should be dispersed. For example, after your death, you may not want the proceeds from the life insurance policy distributed to your beneficiaries until they reach a certain age.
Revocable Life Insurance Trust
Assets in Revocable Life Insurance Trust Will Be Included in Taxable Estate
One reason that a revocable trust is not used as often as an irrevocable trust for insurance planning is that the assets in a revocable trust will be included in your taxable estate when you die. If the revocable trust holds an insurance policy, then the proceeds from that insurance policy will be included in your taxable estate. If you have substantial assets, the inclusion of insurance proceeds in your estate may have adverse estate tax consequences.
Use Revocable Trust If Beneficiaries Are Minor Children
One option with an insurance policy is to name your children (or others) as the beneficiaries on the policy. Then, upon your death, the insurance proceeds will pass directly to those beneficiaries. However, if the beneficiaries are minors or are irresponsible with money, you may not want them to have direct control over the assets. Setting up a revocable insurance trust will solve this problem. You can stipulate in the trust how and when the assets should be distributed to the minors. Furthermore, if you name an entity such as a bank trust department as the trustee, you can have professional management of the assets in the trust.
Use Revocable Trust If You Want to Maintain Control over Trust and Trust Assets
Another reason to use a revocable life insurance trust (as opposed to an irrevocable trust) is if you want to retain control over the trust during your lifetime. With an irrevocable trust, you cannot amend the terms of the trust, change the trustee, alter the beneficiaries, or even terminate the trust. You may have reservations about giving up this much control over an asset as substantial as a life insurance policy. With a revocable trust, however, you can change the terms of the trust, add or subtract beneficiaries, remove assets, change the trustee, or terminate the trust. If the inclusion of the insurance proceeds in your estate is not a tax problem, you may want to set up your life insurance trust as a revocable trust to give yourself control over the trust during your lifetime.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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