Few
people realize that, even though they may have a modest estate,
their families may owe hundreds of thousands of dollars in
estate taxes because they own a life insurance policy with
a substantial death benefit. This is so because life insurance
proceeds, while not subject to federal income tax, are considered
part of your taxable estate and are subject to federal estate
tax. Even though federal tax legislation enacted in 2001
repeals the estate tax, the repeal is not effective until
2010. In the meantime, the rules on the estate tax taxation
of life insurance benefits remain in force.
The solution to this problem is to create an
irrevocable life insurance trust that will own the policy
and receive the policy proceeds on your death. A properly
drafted life insurance trust keeps the insurance proceeds
from being taxed in your estate as well as in the estate
of your surviving spouse. It also protects the trust beneficiaries
from their own “excesses,” against their creditors,
and in the event of divorce. Moreover, the trust also provides
reliable management for the trust assets. Here’s how
the irrevocable life insurance trust works.
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You create an irrevocable life insurance trust
to be the owner and beneficiary of one or more life insurance
policies on your life. You contribute cash to the trust to
be used by the trustee to make premium payments on the life
insurance policies. If the trust is properly drafted, the
contributions you make to the trust for premium payments
will qualify for the annual gift tax exclusion, so you won’t
have to pay gift tax on the contributions.
The life insurance trust typically provides that, during your
lifetime, principal and income, in the trustee’s discretion,
may be paid or applied to or for the benefit of your spouse
and descendants. This allows indirect access to the cash surrender
value of the life insurance policies owned by the trust, and
permits the trust to be terminated if desired despite its being
irrevocable. On your death, the trust continues for the benefit
of your spouse during his or her lifetime. Your spouse is given
certain beneficial interests in the trust, such as the right
to income, limited invasion rights, and eligibility to receive
principal. On the death of your spouse, the trust assets are
paid outright to, or held in further trust for the benefit
of, your descendants. |
