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June 2002 Should you have a life insurance trust? A properly created and managed trust can help you realize the full benefits of your life insurance policy One of the benefits of life insurance is its ability to generate cash to help pay estate taxes. That strategy may be undermined, though, if you are the owner of your life insurance policy. The proceeds paid at your death will be part of your estate; depending on the value of the policy and the net worth of your property, the presence of your life insurance policy in your estate could, ironically, create a tax liability that otherwise would not have existed. One way to keep life insurance proceeds outside your taxable estate is to arrange for your policy to be owned by a special type of trust called an irrevocable life insurance trust. How the trust works. A life insurance trust is a separate legal entity that is established to own a life insurance policy and pay the policy premiums. If you’re planning to buy a life policy, we recommend that you create the trust first and have it buy the policy. That way you are never the policy owner, and there is no risk of including the policy in your estate. If you already own the policy, you can set up the trust and transfer the policy to it. If the transfer is made correctly and you’ve paid careful attention to the tax and legal requirements, the insurance proceeds should be removed from your estate. Whether you can benefit from a life insurance trust depends on your specific situation. Although the 2001 Tax Act increased the amount that can pass to your beneficiaries free of estate tax and supposedly eliminates the estate tax in 2010, a trust may still be a useful planning tool. The size of your estate. The amount exempt from federal estate tax rises from $1 million in 2002 to $3.5 million in 2009. If your estate exceeds the current exemption amount or is likely to grow beyond the exemption amount in the future, an irrevocable life insurance trust could help in two ways:
Let’s say that the bulk of your estate rests in an IRA or a 401(k) account. If your heirs are forced to tap those accounts in order to pay your estate expenses, an ordinary income tax liability is created, and tax-deferred growth stops. An irrevocable trust could help your heirs avoid that outcome by giving them another source of cash. If your estate consists mainly of real estate or a family business, your heirs may not be able to quickly liquidate assets or raise money to pay estate expenses. Insurance proceeds held in a trust may help provide liquidity. What the future holds. The tax rules change constantly, and the same law that gradually reduces and eventually eliminates the estate tax in 2010 restores it in 2011. Long-term planning in this volatile time can be rather complicated. For specific advice tailored to your situation and goals, please contact your Schmidt Westergard & Company professional. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
