Irrevocable life insurance tax planning

By | January 26, 2014

Even people with few assets, may end up owing hundreds of thousands of dollars in estate taxes because they own a life insurance policy with a substantial death benefit that ends up paying out.


Irrevocable life insurance tax planning

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 a federal estate tax. It is essential to plan for the estate tax in order to maximize the amount of wealth that you can pass onto your heirs.


Creating an Irrevocable Life Insurance Trust

On way to solve this problem is to create an irrevocable life insurance trust that will own the policy and receive the policy proceeds on your death to designated beneficiaries. 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. A irrevocable life insurance trust 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.


Using an Irrevocable Life Insurance Trust

The irrevocable life insurance trust will 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.


Irrevocable Life Insurance Trust at Death

At death, the trust continues for the benefit of your spouse during his or her lifetime. Your spouse is given certain beneficial interests inthe 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.