Irrevocable Life Insurance Trust

If you are single and your net estate (including your life insurance) is more than the federal estate tax exclusion amount ($1 million in 2003), or if you are married and your total net estate is more than two exemptions ($2 million in 2003), an irrevocable life insurance trust can reduce your estate taxes.

Remember, life insurance proceeds for which you have any "incidents of ownership" (policies you can borrow against, assign, or cancel, or for which you can revoke an assignment, or name or change the beneficiary) are included in your taxable estate when you die. Estate taxes now start at 41% of every dollar over $1 million and quickly go up to 49% in 2003.

Very simply, an irrevocable life insurance trust owns your insurance policies for you. And since you don't personally own the insurance, it will not be included in your taxable estate. So your estate will pay less in estate taxes, and more of your estate will transfer to your family.

Of course, you could have another person (like your spouse or an adult child) own your insurance for you. That would also keep it out of your estate, but you would not have as much control over the policy. This person could change the beneficiary, take the cash value or even cancel the policy. With an irrevocable life insurance trust, the trustee you select (it must be someone other than you) must follow the instructions in your trust.

An irrevocable life insurance trust also gives you more control over how the proceeds are used. For example, the trustee could make the funds available to pay estate taxes and other final expenses. You could provide your surviving spouse with a lifetime income and keep the proceeds out of both your estates. You could also keep the proceeds in trust and provide periodic income to your children or other loved ones, without giving them the full amount.

Existing policies can be transferred into an irrevocable life insurance trust, but if you die within three years of making the transfer, the death benefits of the policies will be taxed as part of your estate. There may also be a gift tax.

The trustee can also purchase a new policy. But it must be done in a special way so you don't incur a gift tax. Each year, using annual tax-exempt gifts, you can give up to $11,000 ($22,000 if married) to each of the beneficiaries of the irrevocable life insurance trust. (The actual amount given will depend on the premium for the policy.) But instead of giving this money directly to the beneficiaries, you give it to the trustee for them.

The trustee then notifies each beneficiary that a gift has been received on his/her behalf and, unless the beneficiary elects to receive the gift immediately, the trustee will invest the funds--by paying the premium on the insurance policy. Of course, in order for this to work, the beneficiaries must understand not to take the gift now. (By the way, the written notification to the beneficiaries is known as a "Crummey letter," named after the man who first tested it and had it approved by the IRS.)

NOTE: This information is designed to provide a general overview with regard to the subject matter covered and is not state-specific. The authors, publisher and host are not providing legal, accounting or any other advice which purports to be specific to your situation. The contents of this website are believed to be completely reliable. Nevertheless, some material may be affected by changes in the laws or interpretations of such changes since the material was entered on the website. If legal advice or other expert guidance is required, the services of a competent professional in the field of law, accounting, insurance or investments should be sought.

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