Benefits of a Life Insurance Trust

  • Provides immediate cash to pay estate taxes and other expenses after death.
  • Reduces estate taxes by removing insurance proceeds from your estate.
  • Inexpensive way to pay estate taxes.
  • Avoids probate and proceeds 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 proceeds if beneficiary is incapacitated.

Who Has to Pay Estate Taxes?
Your estate will have to pay estate taxes if its net value is more than the “exempt” amount set by Congress at the time of your death. The current schedule is as follows:

Year of Death Estate Tax “Exemption”
2006, 2007, 2008$2,000,000
2009 and After$3,500,000

In addition, family-owned businesses and farms that qualify can take a special deduction permitting an exemption of up to $1.3 million from estate taxes.

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 taxes are reduced.

Let’s say you are married, with a combined net estate of $4 million; $1 million of which is life insurance. With a tax planning provision in a revocable living trust or will, you can protect up to $3 million (in 2004 and 2005) from estate taxes. But your estate would have to pay approximately $480,000 in estate taxes on the additional $1 million. With an insurance trust, the $1 million in life insurance would not be in your estate. That would save your family $480,000 in estate taxes.

How Does an Irrevocable Life 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. The trust beneficiaries you name will receive the trust assets after you die.

The trustee purchases an insurance policy (or acquires an existing policy) naming you as the insured, and the trust as owner and (usually) beneficiary of the policy. 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 IRA’s other retirement benefits), and then distributes them to the trust beneficiaries as you have instructed.

Naming the Trust As Beneficiary of the Insurance Policy
If you name an individual as beneficiary of an insurance policy and that person is incapacitated when you die, the court will probably take control of the policy. Most insurance companies will not knowingly pay to an incompetent person, and will usually insist on court supervision. However, 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.