Life Insurance Trust
A life insurance trust is a container used to keep life insurance proceeds exempt from estate tax. The trust holds the life insurance policy and removes the proceeds from your estate. The proceeds are protected and will not be subject to probate.
Metaphorically speaking, a life insurance trust is similar to a safe deposit box. Life insurance policies are a legal contract which documents the distribution of proceeds. The policy is placed inside the trust and managed by a designated Trustee.
Although life insurance trusts protect the estate and keep proceeds exempt from taxes, there are drawbacks to this estate planning strategy. Perhaps the biggest drawback is the fact that once the life insurance trust is established, the insurance policy cannot be changed. If family circumstances change, a life insurance trust eliminates the ability to alter the trust and can lead to potential problems.
In essence, the trust is the beneficiary of the life insurance policy. The policyholder cannot serve as trustee of their own trust. Typically, Trustee's are an independent third party such as a bank, trust company or estate planning lawyer. Although the trust is controlled by the Trustee, the insured party retains control over designated beneficiaries and outlines terms of distribution.
There are important decisions to make when setting up a life insurance trust. Who will administer the trust? Who will be named as beneficiaries? How will funds be distributed? Since the trust cannot be altered once it is executed, careful consideration should be given. Take the necessary time to ensure the life insurance trust is constructed exactly the way you want it.
Once a life insurance trust is established, it becomes irrevocable; meaning you cannot get the policy back. When arranging the irrevocable life insurance trust, the policyholder must elect a schedule of distribution.
Proceeds from the policy can be paid immediately, monthly or through annual distributions. Provisions can be made to provide funds to beneficiaries upon reaching certain milestones such as graduating from college, getting married or starting a business.
Irrevocable living insurance trusts (ILIT) are a good choice for people with heirs who receive government assistance. Life insurance distributions can be strategically planned so as not to interfere with the beneficiary's ability to receive government aide or benefits.
ILIT's allow the insured to "gift" up to $10,000 per year to anyone they choose, tax-free. Policyholders can gift this sum of money to as many people as they want. Married couples are allowed to gift up to $20,000 per person, annually.
The annual life insurance premium payment is considered a gift to the named beneficiaries. As long as the premium payments equal no more than $10,000 per beneficiary (or $20,000 for married couples), no gift tax will be owed.
Life insurance trusts are complex, yet offer considerable flexibility in their arrangement. Each trust is as unique as the person who establishes one. They are a safe way to protect your estate and provide for your loved ones.
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