Irrevocable Life Insurance Trusts
Life insurance used for estate planning solves many estate issues by providing liquidity at death. The usefulness of life insurance is reduced when proceeds are taxable in a decedent’s estate.
Highly successful clients can give ownership of their life insurance policy away to keep it out of their taxable estate. Since giving the policy to children runs the risk of losing the policy to creditors, bankruptcy, or to a child’s divorce, it behooves the client to create an entity that is there to pay-out the death benefit according to the client’s wishes.
SOME OF THE ADVANTAGES OF AN IRREVOCABLE LIFE INSURANCE TRUST (ILIT) INCLUDE:
- Proceeds not included in insured’s estate
- Provides estate liquidity without taxation of proceeds
- Avoids both Federal and State death taxes
- With use of Present Interest Gifts of $14,000 per beneficiary and Lifetime Gift Tax Exemption of $5,450,000 as of 2016, avoids gift tax
SOME OF THE DISADVANTAGES INCLUDE:
- Client must give up direct control over policy and gifts of premium
- Transfer must be complete and permanent
- Client cannot change beneficiary or ownership of policy and cannot have any incident of ownership
- Events can later change with divorce, financial situation, stability of children etc. yet policy cannot be changed since insured does not own policy
- TAX IMPLICATIONS OF AN ILIT:
- If trust is only funded with life insurance, no taxable income
- If trust is funded with investment assets, trust pays lax
- To the extent income is paid to beneficiaries, beneficiaries will pay tax
- However, if the trust is treated as an intentionally defective grantor trust, income earned by the trust is taxed to Grantor yet the trust proceeds are kept out of the Grantor’s estate
An Irrevocable Life Insurance Trust can be used as a “Dynasty Trust” that can benefit not only children but grandchildren and great grandchildren. Dynasty Trusts are a long term trust created specifically for all generations. Dynasty Trusts con survive 21 years beyond the death of the last beneficiary olive when the trust was written. If an insured had a grandchild age one when the trust is created, the Dynasty Trust could last over l00 years.
Tax savings occur at the death of the descendants, such as children and grandchildren. Since the Generation Skipping Tax (GSTJ exemption is assigned to the trust, the death benefit and trust assets are not taxed at the children or grandchildren’s death. There is also no federal estate tax on assets when the trust ends and no estate tax al the beneficiary’s deaths; this con save 70% of the estate through three generations.
The GST Exemption is $5,450,000 per person as of 2016.
More and more individuals who have had 401 (k)s for years, homes in appreciating areas and other investments hove taxable estates (yes, even now). An ILIT provides a means of providing liquidity at death without having the assets included in the deceased’s estate. If a client is projected to have a taxable estate, an ILIT can have a dramatic impact on the amount that goes to heirs. Irrevocable life Insurance Trusts need to be prepared by an estate planning attorney to ensure compliance with state and federal lax laws and to make sure the proceeds pass outside the insured’s estate. Keep in mind existing policy is contributed to an Irrevocable Life Insurance Trust, there is a three-year wait before the policy proceeds pass outside of the insured’s estate. If the insured is healthy, it may be better to have the Trustee purchase a new policy for the trust so that the insured has no incidence of ownership and the death benefit passes outside the insured’s estate from day one. Signature Guaranteed Universal Life is a great match for an Irrevocable Life Insurance Trust. It is a low cost permanent life insurance policy that does not accumulate cash value but provides a guaranteed death benefit as long as premiums are paid and loans and withdrawals are not taken. That, in essence, is how an ILIT should work by minimizing cost and providing a permanent guaranteed benefit.
Source: American National