What is a Life Insurance Trust?

Understanding life insurance trusts is beneficial for the sake of transferring wealth without paying as much taxes. A life insurance trust can be an irrevocable trust which is used to pay the estate taxes after death of the grantor. The trust is set up within the estate to help pass the wealth from one generation to another. It can also be known as an irrevocable life insurance trust (ILIT) or a wealth replacement trust.

The grantor holds the policy on his or her own life making the death benefits included in the gross estate. In order to transfer the life insurance as a gift a third party or an entity such as the ILIT could help make the transfer recognized as a gift. This is known as the Crummey rule, where the trust owns the policy and the premium is gifted to the trust using up the annual gift exclusion.

If you remember from "Understanding Bypass Trusts", there is a lifetime $1 million gift exclusion. By using the Crummey rule the ILIT can avoid depleting the lifetime gift exclusion. There is an annual gift tax exclusion equal to $13,000 in 2009 which is up from $12,000 in 2008. Make sure to check the annual exclusions limit in the year you plan to make your annual gifts. In some cases, in order to evade paying taxes unduly, the grantor can gift up to the annual gift exclusion limit to the beneficiary and the beneficiary pays the premium of the life insurance in the ILIT. Keep in mind also that the annual exclusion applies mutually exclusively to each beneficiary. For example, if someone gifts $13,000 to his/her offspring, they may also gift another $13,000 to a charity or to another beneficiary. That means that the annual gift exclusion applies to each beneficiary non-summarily.

The life insurance trust is not without its downsides. First of all, the policyholder cannot receive any benefits from the policy while alive. The trust must be irrevocable, and there must be appointed a trustee. If the grantor dies within three years of transferring the life insurance policy over to the ILIT, he or she is still considered owner of the policy and any proceeds will be included in his or her gross estate.

In order to avoid these issues it is best to make the trust irrevocable at the outset and appoint a trustee to purchase the life insurance policy, gifting the premiums to the desired beneficiaries where the beneficiaries pay the premium on the policy. This maximizes the full benefits without having to pay as much future estate taxes.

If you are serious about a life insurance trust consult an estate planner and mention that you want to set up an irrevocable life insurance trust that is in line with the Crummey rule. The estate planner will be able to assist you and connect you with a trustee.




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