As, you probably know, life insurance proceeds are not taxable for income tax purposes. However, these proceeds are taxable for Federal Estate Tax Purposes. Unfortunately, this causes many families to suffer unexpected financial burdens after the death of a loved one because Federal Estate Taxes are approximately 50% on all assets over $600,000.00. For example, you may buy a $500,000.00 Life Insurance policy thinking this is more than sufficient to pay expenses and provide an inheritance to your family. However, one-half of that amount (or $250,000.00) may be lost to Taxes. Thereafter, the family must struggle to pay expenses. If your spouse receives the proceeds, the Federal Estate Taxes will not have to be paid immediately. However, these Taxes will be payable at the death of your spouse.Fortunately, there are ways of avoiding Federal Estate Taxes on Life Insurance proceeds. We can establish an Irrevocable Living Trust (or Life Insurance Trust) to “own” the policy. Under this device, the Trust owns the policy; but the Trust document controls the Trustee’s actions and distribution of proceeds. Routinely, the surviving spouse receives the income from the Trust for life and has certain rights to use the principal, if necessary. After the surviving spouse dies, the Trust terminates and the children inherit the remainder. (If the children are of tender years or experience, the Trust can stay in place for their protection.)
There are certain requirements for an Insurance Trust. However, these are insignificant in the light of the benefit derived. Some requirements are:
If you transfer a life insurance policy to the Trust, you must survive for three (3) years after the transfer.
You must give up control of the policy to the Trust so that you cannot change the policy’s terms or beneficiaries or borrow against the policy.
The Trust must be irrevocable so that you cannot change the Trusts terms or beneficiaries.
Your Trust will have to pay premiums. There are notice requirements to beneficiaries when you contribute money to the Trust for this purpose.
You or your spouse cannot serve as sole trustee.
Considering the dramatic tax savings afforded by this device, the compliance requirements are well worth the effort for persons with assets and insurance exceeding $600,000.00.
Even if the tax savings are not necessary or desirable, the Trust protects your beneficiaries from squandering the funds of life insurance.
Our Estate Planning, Probate and Elder Law Department is well prepared to draft a Living Trust to satisfy our clients’ needs.
Kimberly A. Paton is a Partner at WJ&L, LLP and Chairperson of the Estate Planning, Probate and Elder Law Department.