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Life Insurance Trusts - Life Insurance Benefits Free of Estate Tax |
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Many people have been told that the death benefit of a life insurance policy is not taxable. While this is, with some exceptions, true with respect to federal and state income taxes, you may be surprised to learn that the full amount of the death benefit of a life insurance policy is subject to federal and state estate tax. An irrevocable life insurance trust will permit you and your family to eliminate the estate tax consequences of life insurance.
An irrevocable life insurance trust is one of many alternative types of Irrevocable Trusts which may own one or more policies insuring your life. In order to avoid the imposition of estate tax, the trust must be drafted so that you do not have any “incidents of ownership” with respect to any policy insuring your life which is owned by the trust. For example, you cannot have any control over any decision concerning the life insurance policy or policies and the cash value and death benefits of those policies cannot be used to pay any obligation or debt owed by you or your estate. All decisions and actions required for the purchase, receipt and administration of life insurance policies must be made by your trustee.
While you cannot receive any personal benefit from a policy owned by the trust, an irrevocable life insurance trust may provide financial protection for your spouse, children, and grandchildren. Also, death benefits paid from a policy collected after your death may be held in further trust for the benefit of your spouse and family without estate taxation of those benefits in the estates of your spouse or other family members.
An independent trustee may be given broad discretion to distribute principal. That discretion, in turn, allows the trustee to terminate the trust and distribute or dispose of the life insurance policies if your family financial circumstances have changed.
Unless you give one or more fully paid up policies to the trust, you must have a plan for the ongoing payment of premiums by the trustee. Most grantors choose to make annual gifts to their life insurance trusts which the trustee uses to pay annual premiums. If the life insurance trust includes certain withdrawal right provisions, all or a portion of your annual gifts to the trustee will qualify for gift tax annual exclusion treatment, provided that you and trustee comply with rules governing those gifts.
With careful planning, drafting and execution, an irrevocable life insurance trust can provide a substantial financial and tax benefit to your family.
For further information concerning annual exclusion gift tax rules, see Irrevocable Trusts - Making Gifts to Your Trust Without Having to Pay Gift Tax.
This article is intended to acquaint the reader with some general principles which govern irrevocable life insurance trusts and is not intended to convey legal advice with respect to the reader’s specific circumstances. Specific planning opportunities which employ irrevocable life insurance trusts require detailed legal analysis and drafting techniques and the reader is therefore encouraged to call one of the following attorneys who practice in the Trusts and Estates group at Quinlivan & Hughes, P.A. 320-251-1414.
Kevin A. Spellacy
John H. Wenker
Robert P. Cunningham
W. Benjamin Winger
Bradley W. Hanson
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