A life insurance policy can protect loved ones while bringing you some much-needed peace of mind and financial benefits. By placing a life insurance policy in a trust, it may be possible to shelter assets from estate taxes. Read on to learn more.
There are two types of life insurance trusts: revocable and irrevocable. With a revocable trust, the grantor can make changes to the terms of the trust or dissolve it at any time. Once an irrevocable trust is established, the grantor can’t amend or cancel it. However, it's the irrevocable life insurance trust that can potentially minimize any estate tax liability.
Naming your trust as the beneficiary of your life insurance policy can give you more control over how the proceeds are distributed. For example, if you name your spouse or partner as the beneficiary of your life policy and he/she is incapacitated.
At the time of your death, the court may require the appointment of a guardian or conservator to manage the proceeds on their behalf. However, if your trust is the beneficiary of the policy, the trustee can use the proceeds to provide for your spouse or partner directly, without any court interference.
Other benefits can include:
In some cases, life insurance can add complexities to the estate planning process. That's where an irrevocable life insurance trust (ILIT) can help you better manage taxes and other implications of passing assets to the next generation.
An ILIT is a powerful estate planning vehicle you can use in tandem with a life insurance policy to manage financial issues around life insurance assets and benefits.
Like other trusts, an ILIT is its own legal entity that can hold other assets. It has its own tax ID number. A grantor creates a trust which is managed by a trustee. Beneficiaries are the people, nonprofits or other organizations picked to get the assets after a payout. These terms are consistent across different types of life insurance trusts, and noninsurance-related trusts, as well.
When setting up an ILIT, the grantor can place a life insurance policy inside the trust. This means that the trust owns the policy, not the grantor. It can be a new policy or existing policy, but there can be some additional tax challenges for existing policies with a large cash value.
Putting the life insurance policy in the trust can remove it from the grantor's personal assets. As an irrevocable trust, once the life insurance is owned by the trust, you can't take it back. But this also means that, if you pass away and the life insurance policy makes a substantial payout, the payout goes to the trust, excluding it from your estate. For large estates, this can lead to major tax savings when passing on assets to heirs.
The trustee is responsible for managing payouts to the beneficiaries. This person can ensure a young heir doesn't squander his or her inheritance, while ensuring the grantor's wishes are followed.
In addition to the tax benefits and ability to put a trusted person in charge, a trust also adds privacy to an estate settlement, as trusts don't have to be approved through the public probate process by a judge.
Revocable life insurance trusts come with the flexibility of allowing the grantor to make changes to the trust at any time. This can be helpful in cases when a situation is expected to change over time and modifications may need to be made. For example, this may be the case of creating a trust to benefit young children, a special needs child, or a young adult. It's important to note, however, that a revocable designation for the trust means that the policy would likely still be considered part of the grantor's estate.
If you are picking a new life insurance policy while setting up an ILIT, you are in a great position to pick an ideal policy for your personal wishes and family's needs. This can be a term life insurance policy but more likely a permanent policy, like whole life insurance or universal life insurance.
It is common to put permanent universal life insurance policies in a trust because they offer a guaranteed death benefit. A term policy may expire before the death of the grantor, then there would be no funds to distribute from the trust.
There is no hard rule about what types of life insurance you should include in your ILIT, so it’s essential to work with a financial professional, tax professional or trusted legal counsel to ensure you reach your desired result.
Trusts can solve additional pain points for beneficiaries, but professional guidance is key to helping ensure it all works out as planned without unintended consequences. For example, in some cases, benefits could increase someone's assets enough that he or she could lose out on government benefits like Medicaid.
This is where financial professionals and tax experts are even more important. If you have any doubts about working with a life insurance trust, consider working with an expert; it can save you and your family significant stress and money down the road.
While there may be some paperwork and upfront costs when getting started, creating a life insurance trust can lead to a big payoff in tax savings and added control over your estate. Setting up a life insurance trust can be a complex endeavor, so it's best to seek the specific expertise of a qualified estate planning attorney who specializes in trusts.
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