Description/Scope

Life Insurance Trusts

While it may be desirable to obtain more life insurance to provide
financial protection for dependents or other reasons, additional life
insurance adds to the federal estate tax burden for your estate. An
irrevocable life insurance trust offers a solution to the spiraling estate
taxes that result from increasing your life insurance.

Federal estate tax burden: At your death, your life insurance is
included in your estate. This means that you have to buy more life
insurance so that you can provide for your dependents and pay the
additional taxes - unless you use a life insurance trust to own the
additional insurance.
Setting up life insurance trusts: Instead of purchasing the life
insurance yourself, a separate life insurance trust is created to own
the additional life insurance policy.
Distributing assets: The beneficiaries of the trust will receive
assets from the trust after your death. The trust assets may be the
life insurance proceeds or the loans made by the trust to the estate
to pay estate taxes.

Click here to find out about:
Trust Beneficiaries
Collecting the Proceeds
Making Withdrawals

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Federal Estate Tax Burden

Stan is single and has a small business worth $900,000, a home worth
$250,000, a car worth $30,000, and $20,000 in cash. Federal estate
taxes alone on this estate of $1,200,000 would amount to $235,000.
Stan decides to buy a $250,000 life insurance policy to provide the
necessary liquidity. However, the life insurance increases the value of his
estate from $1,200,000 to $1,450,000, which in turn, increases the
federal estate tax to approximately $340,000. The $250,000 policy
won't be enough.

Not only does Stan have to have additional life insurance to solve his
initial liquidity problem of $235,000, he also has to buy even more life
insurance to cover the additional tax cost associated with an increase in
his estate that is caused by the additional life insurance. Stan would have
to buy approximately $400,000 to $450,000 in life insurance to solve his
liquidity problem.

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Setting up Life Insurance Trusts

Irrevocable: A life insurance trust is irrevocable; after it has been
established, none of its terms can be changed.

Trustee: As with all trusts, a trustee is required for a life insurance trust.
The trustee can be an individual or a bank. However, the trustee cannot
be you, and in many cases it is advisable that your spouse not serve as
trustee.

Obtaining Life Insurance: An application for new life insurance should
be made by the trust, not by you as an individual. It is possible to transfer
an existing life insurance policy into a trust, but the life insurance will still
be included in your estate unless you live for at least three years after the
transfer.

Ownership/Beneficiary: The trust will be both the owner and the
beneficiary of the life insurance. This means that at your death, the life
insurance proceeds will be paid into the trust.

Paying the Premiums: The trust will need to make the insurance
premium payments to the life insurance company. The trust will not likely
have any funds to make the premium payments, so you will need to
transfer funds into the trust to make the premium payments. You should
not make the insurance premium payments directly yourself.

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Distributing Assets

Generally, no distributions are made from the trust until after your death
and the collection of the life insurance proceeds. You can then provide
for immediate distribution or you can provide for periodic distributions
over a period of years. Keep in mind that if the trust has loaned funds to
your estate or purchased assets from your estate, the trust may be
distributing the loans or the purchased assets, instead of the cash from the
life insurance.

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Trust Beneficiaries

The trust will need beneficiaries to receive the assets from the trust at a
future time. You choose the beneficiaries when you set up the trust.
However, the trust beneficiaries cannot be changed later. Often the
beneficiaries of a life insurance trust are the same beneficiaries as under
your will or living trust. If you decide to include your grandchildren as
beneficiaries, you will need to take into consideration the effect of the
generation skipping tax.

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Collecting the Proceeds

At the time of your death, the life insurance proceeds will be paid into the
trust. Because the estate may need the life insurance proceeds to pay
estate taxes, the proceeds will need to be moved from the trust to the
estate. This can be accomplished by loaning the proceeds to the estate or
by having the trust buy assets from the estate.

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Making Withdrawals

Your contributions to the trust to make the life insurance premiums are
considered to be gifts to the beneficiaries of the trust. Generally, you will
want to keep these transfers to a total annual amount of less than
$10,000 per beneficiary so that your contributions will qualify for the
$10,000 annual exclusion. The $10,000 annual exclusion will only be
available if you give your beneficiaries the right to withdraw the
contributions for at least a 30 day period after you make the
contributions. However, if they do make the withdrawals, the funds will
not be available to make the insurance premiums. If you don't give the
beneficiaries the right of withdrawal, you will give up the $10,000 annual
exclusion. This will mean that your transfers into the trust will have the
undesirable effect of using up part of your $625,000 exemption (an
amount that is scheduled to increase to $1,000,000 by 2006).