Reducing Estate Taxes with Insurance Trusts
While insurance proceeds are not subject to income taxes, the proceeds are subject to estate taxes in the decedent's estate unless the policy is owned properly. One way to exclude these proceeds from your taxable estate at death is to set up an irrevocable life insurance trust.

Once the trust is set up, you can either transfer an existing insurance policy or the trustee (you cannot serve as trustee) can purchase a new life insurance policy. If you transfer an existing policy to the trust and die within three years of the transfer, the proceeds will be drawn back into your estate for estate tax purposes.

You will make annual gifts to the trust so that the trustee can pay the policy premium. In order to qualify for the annual gift tax exclusion of $11,000 ($22,000 with your spouse), the assets transferred must represent a present interest for the beneficiaries. In other words, the beneficiaries must have the ability to withdraw the money now. Normally, when the cash is received the trustee will send a written notice to the beneficiaries, giving them 30 days to demand the assets. After the 30-day period, the beneficiaries' right to withdraw the gift lapses and the trustee will pay the insurance premium.

After your death, the trust receives the insurance proceeds and distributes the proceeds in accordance with the trust's terms. There can be no explicit instructions to the trustee to pay the estate tax liabilities of the insured. However, the trust can have the power to loan money to the estate or to exchange assets with the estate to provide liquidity for paying estate taxes. In order to ensure that the life insurance proceeds are not considered part of your taxable estate, the trust must be irrevocable and you cannot retain any incidents of ownership over the assets in the trust. Incidents of ownership include the power to change the beneficiary, to surrender or cancel the policy for a loan, or to obtain a loan. You can stop funding premiums, but you cannot recover any sums already paid to the trust.

An irrevocable life insurance trust can be a powerful estate tax-savings tool. Before setting one up, however, it is important to consider all of the pros and cons. Although the estate tax savings can be substantial, you are giving up control of the life insurance policy to obtain these savings. Please call us if you would like to discuss whether this type of trust is appropriate for your circumstances.

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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