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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2010...................................N/A (repealed)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
Parkwood Office Center - 2370 130th Ave. N.E., Suite
103 - Bellevue, WA 98005
Phone: 425.451.3583.. Fax:
425.452.0153 ..E-mail: contact@pricefarrington.com
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