How to Reduce
or Eliminate Your Estate Tax Cost
1.
What does a life insurance trust do?
2. What are estate taxes?
3. Who has to pay estate taxes?
4. What makes up my net estate?
5. How does an insurance trust reduce estate taxes?
6. What if my estate is larger than this?
7. How does an irrevocable insurance trust work?
8. Can I be my own trustee?
9. Why not just name someone else as owner of my insurance
policy?
10. How does an insurance trust give me control?
11. Are there other benefits to naming the trust as beneficiary
of an insurance policy?
12. Who can be beneficiaries of the trust?
13. Where does the trustee get the money to purchase a new
insurance policy?
14. Are there any restrictions on transferring my existing
policies to an insurance trust?
15. Can I make any changes to the trust?
16. When should I set up an insurance trust?
17. Should I seek professional assistance?
18. Benefits of Life Insurance Trusts
1. What does a life insurance
trust do?
An irrevocable life insurance trust lets you reduce or even eliminate
estate taxes so more of your estate can go to your loved ones. It also
gives you more control over your insurance policies and the proceeds that
are paid from them.
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2. What are estate taxes?
Estate taxes are different from, and in addition to, probate expenses
and final income taxes (which must be paid on income you receive in the
year you die). Some states also have their own death/inheritance taxes.
Federal estate taxes are expensive – in 2003 they start at 41% and
quickly increase to 49%. They must be paid in cash, usually within nine
months after you die. Since few estates have this kind of cash, assets
often have to be liquidated. But estate taxes can be substantially reduced
or even eliminated – if you plan ahead.
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3. Who has to pay estate
taxes?
Your estate will have to pay estate taxes if its net value when you die
is more than the "exempt" amount set by Congress at that time.
Here is the current schedule:
Year
of Death.........Estate Tax “Exemption”
2006, 2007 & 2008.....................$2 million
2009.......................................$3.5 million
2010...................................N/A (repealed)
2011.........................................$1 million
In
addition, family-owned businesses and farms that qualify can take a special
deduction of up to $675,000, making a total of up to $1.3 million exempt
from estate taxes. (This deduction will be eliminated in 2004.)
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4. What makes up my net
estate?
To determine your current net estate, add your assets then subtract your
debts. Many people are surprised that insurance policies for which they
have any "incidents of ownership" are included in their taxable
estates. This includes policies you can borrow against, assign or cancel,
or for which you can revoke an assignment, or can name or change the beneficiary.
You
can see how life insurance can increase the size of your estate--and the
amount of estate taxes that must be paid.
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5. How does an insurance trust reduce estate taxes?
The insurance trust owns your insurance policies for you. Since you don't
personally own the insurance, it will not be included in your estate --
so your estate taxes are reduced.
Let's
say you are married, with a combined net estate of $2.5 million, $500,000
of which is life insurance. With a tax planning provision in a revocable
living trust or will, you can protect up to $2 million in 2003 from estate
taxes. But your estate would have to pay $210,000 in estate taxes on the
additional $500,000. With an insurance trust, however, the $500,000 in
insurance would not be included in your taxable estate. That would save
your family $210,000 in estate taxes.
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6. What if my estate
is larger than this?
If your estate will still have to pay estate taxes after you transfer
your insurance to a trust, you can reduce your estate tax costs by having
the trust buy additional life insurance. Here are three very good reasons
to do this:
1.
If the trust buys the insurance, it will not be included in your estate.
The death proceeds, which are not subject to probate or income taxes,
will flow to your beneficiary free from estate taxes.
2.
Insurance proceeds are available immediately after you die, so your assets
will not have to be liquidated to pay estate taxes.
3.
Life insurance can be an inexpensive way to pay estate taxes and other
expenses. You can leave more to your loved ones.
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7. How does an irrevocable insurance trust work?
An insurance trust has three components. The grantor is the person creating
the trust – that's you. The trustee you select manages the trust.
And the trust beneficiaries you name will receive the trust assets after
you die.
The
trustee purchases an insurance policy with you as the insured and the
trust as owner and (usually) beneficiary. When the insurance benefit is
paid after your death, the trustee will collect the funds, make them available
to pay estate taxes and/or other expenses (including debts, legal fees,
probate costs, and income taxes that may be due on IRAs and other retirement
benefits), and then distribute them to the trust beneficiaries as you
have instructed.
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8. Can I be my own trustee?
Not if you want the tax advantages we've explained. Some people name their
adult children as trustee(s), but often their children don’t have
enough time or experience. Many people choose a corporate trustee (bank
or trust company) because they are experienced with these trusts. A corporate
trustee will make sure the trust is properly administered and the insurance
premiums promptly paid.
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9. Why not just name
someone else as owner of my insurance policy?
If someone else, such as your spouse or adult child, owns a policy on
your life and dies first, the cash/termination value will be in his/her
taxable estate. That doesn't help much.
But,
more importantly, if someone else owns the policy, you lose control. This
person could change the beneficiary, take the cash value, or even cancel
the policy, leaving you with no insurance. You may trust this person now,
but problems could arise later on. An insurance trust is safer –
it lets you reduce estate taxes and keep control.
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10. How does an insurance trust give me control?
With an insurance trust, your trust owns the policy. The trustee you select
must follow the instructions you put in your trust. And, with your insurance
trust as beneficiary of the policies, you will have more control over
the proceeds.
For
example, you could tell the trustee to use the proceeds to purchase assets
from your estate or revocable living trust, providing cash to pay expenses.
You can provide your spouse with lifetime income and keep the insurance
proceeds out of both of your estates. You could also keep the money in
the trust and have the trustee make periodic distributions to the beneficiaries
of the trust.
By
contrast, if your spouse or children are beneficiaries of the policy,
they will receive all of the money right away – and you will have
no control over how the money is spent. If your spouse is beneficiary
and you die first, all of the proceeds will be in your spouse's taxable
estate – which could create a tax problem. And your spouse (not
you) will decide who will inherit any remaining money after he or she
dies.
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11. Are there other
benefits to naming the trust as beneficiary of an insurance policy?
Yes. If you name an individual as beneficiary of a policy and that person
is incapacitated when you die, the court will probably take control of
the money. Most insurance companies will not knowingly pay to an incompetent
person, and will usually insist on court supervision. But
if your trust is the beneficiary of the insurance policy, the trustee
can use the insurance proceeds to provide for this person without court
interference.
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12. Who can be beneficiaries
of the trust?
You can name any person or organization you wish, but most people name
their children and/or spouse.
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13. Where does the trustee
get the money to purchase a new insurance policy?
From you, but in a special way. If you transfer money directly to the
trustee, there could be a gift tax. But you can make annual tax-free gifts
of up to $11,000 ($22,000 if your spouse joins you) to each beneficiary
of your trust. (This amount may be adjusted each year for inflation.)
If you give more than this, the excess is applied to your federal gift/estate
tax exemption and could reduce it over time.
Instead
of making a gift directly to a beneficiary, you give it to the trustee.
The trustee then notifies each one that a gift has been received on his/her
behalf and, unless he/she elects to receive the gift now, the trustee
will invest the funds – by paying the premium on the insurance policy.
Of course, the beneficiaries must understand not to take the gift now.
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14. Are there any restrictions on transferring my existing
policies to an insurance trust?
Yes. If you die within three years of the date of the transfer it will
be considered invalid by the IRS and the insurance will be included in
your taxable estate. There may also be a gift tax. Be sure to discuss
this with your attorney.
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15. Can I make any changes
to the trust?
An insurance trust is irrevocable, so you can't make changes after it
has been set up. Read your trust document carefully and be sure it's exactly
what you want before you sign.
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16. When should I set
up an insurance trust?
You can set up one any time, but because the trust is irrevocable, many
people wait until they are in their 50s or 60s. By then, family relationships
have usually settled—and you know whom you want to name as a beneficiary.
Just
don't wait too long—you could become uninsurable. And remember,
if you transfer existing policies to the trust, you must live three years
after the transfer for it to be valid.
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17. Should I seek professional assistance?
Yes. If you think an irrevocable insurance trust would be of value to
you and your family, talk with an insurance professional, estate planning
attorney, corporate trustee, or CPA who has experience with these trusts.
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18. Benefits of Life
Insurance Trusts
• Provides immediate cash to pay estate taxes and other expenses
after death.
• Reduces estate taxes by removing insurance from your estate.
• Inexpensive way to pay estate taxes.
• Proceeds avoid probate and are free from income and estate taxes.
• Gives you maximum control over insurance policy and how proceeds
are used.
• Can provide income to spouse without insurance proceeds being
included in spouse's estate.
• Prevents court from controlling insurance proceeds if beneficiary
is incapacitated.
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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.
Price
& Farrington, PLLC - Attorneys and Counselors
at Law
12501 Bellevue-Redmond Road, Suite 215 ....Bellevue,
Washington 98005
Phone: 425.451.3583.. Fax: 425.452.0153 ..E-mail: contact@pricefarrington.com
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