It has become very expensive to live the “American Dream” – a house, college educations, vacations, retirement planning, etc. Two income families have become the norm and the “Dream” has, often out of necessity, been modified or postponed. If there is a premature death of one spouse, how do you protect the family – which can include a surviving spouse, elderly parents, minor children and children from a prior marriage?
A Life Insurance Trust can be the answer. Life insurance provides liquidity and flexibility to solve the problems. The Trust protects the insurance from taxes and provides a vehicle to distribute the proceeds as you see fit to protect your family.
Although life insurance proceeds are not taxed for income tax purposes, they are taxed for Federal Estate Tax Purposes if the total estate (including life insurance proceeds) exceeds the Unified Credit (“UC”), the Federal Estate Tax rate is approximately 50%. (The UC is presently $650,000 and will increase to $1,000,000 by 2006.) If your estate exceeds the amount of the UC, and you buy a life insurance without a Life Insurance Trust, to pay expenses and provide an inheritance, 50% of the insurance may be lost to taxes.
Further, insurance may be intended to provide an inheritance for your spouse, and your children, and your parents, etc. You do not want multiple policies and you should not expect that one named beneficiary will, or could, share the proceeds as you would deem appropriate.
Life Insurance Trusts
Fortunately, there is a legal way to avoid taxes and to make sure your distribution plan is put in place. An Irrevocable Life Insurance Trust, if prepared and administered properly, can save all of the taxes applicable to the insurance proceeds. The Trust owns and is the beneficiary of the policy; the Trust document controls the distribution of monies. 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 (outright or in a further trust). The terms of the Trust can be modified to address any family situation to protect all parties.
There are certain requirements for an Insurance Trust. However, they are not significant in light of the dramatic tax benefits and family planning potential. Some requirements are:
(a) If you transfer a life insurance policy to the Trust, you must survive for three (3) years after the transfer.
(b) 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.
(c) The Trust must be irrevocable so that you cannot change the Trust terms or beneficiaries.
(d) Your Trust will have to pay premiums. There are notice requirements to beneficiaries when you contribute money to the Trust for this purpose.
(e) You or your spouse cannot serve as sole trustee; but you can be a Co-Trustee.
Our Estate Planning, Probate and Elder Law Department is well prepared to draft a Living Trust to satisfy our clients’ needs.