Life Insurance Trust – Who Owns Your Life Insurance Policy?

Unbiased Financial Information Provided by Financial Wisdom.

Life insurance proceeds are not subject to income tax.  However, they may be included in a taxable estate if you or your spouse owns the policy.  Using a Life Insurance Trust can enable you to avoid income taxes.

Consider a Life Insurance Trust

Life insurance proceeds are generally part of your estate and may be subject to estate taxes depending on the size of your taxable estate. This influx of cash to the estate, while usually quite large and often needed for funeral expenses, taxes and debts, can cause confusion. In some cases, the life insurance proceeds are what increases the estate to the size where it starts to owe taxes.

Just how the life insurance is owned and paid for can nearly double its monetary value if estate taxes do not have to be paid on it.  For 2017, taxable estates over $5.49 million are taxed at 40%.

How do you avoid these estate taxes?

Set up an Irrevocable Life Insurance Trust, commonly called an ILIT. Note that an ILIT is irrevocable which means you can’t change your mind after it is established. From this restriction and the nature of life insurance come the many tax and financial advantages.

Here’s how it works

Determine your specific need. Often an ILIT is used as the most effective way possible to pay estate taxes. Usually premiums represent pennies on the dollar of benefits paid on your death. Using the insurance proceeds to cover estate taxes may be a better choice than having to liquidate other assets.

Set up the trust. You need professional assistance in setting up an ILIT. Even if your insurance company offers to draft the documents, be sure your attorney reviews them. Your attorney will be more familiar with your situation and more aware of local laws affecting your estate. You will have to select a trustee for the ILIT. Usually, personal trusteeship of the trust is the most cost efficient, but your trustee may need competent advice for the simple reporting requirements.

Fund the trust. The trust owns the life insurance policy and pays the premiums. You may be able to make annual gifts to the trust to cover the premiums. However, there are special rules about this and you should cover this issue with your attorney.

Buy the insurance policy. The trust purchases life insurance on your life with its assets. Along with being the owner, the trust is the beneficiary of the policy and your heirs are the beneficiaries of the trust. When you are considering what type of life insurance to buy, along with term and cash value whole life, consider a “second-to-die” policy. This is a relatively new form of life insurance policy and can be very attractive as part of a total family estate plan.

Final thoughts

No one likes to think about dying. And buying life insurance is usually not something most people eagerly do. However, life insurance can provide the funds needed to care for your loved ones after you pass on. Life insurance trusts have become a common way to make sure you have structured your affairs to minimize estate taxes and maximize what is available for your loved ones.

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