Save Death Taxes with an Irrevocable Insurance Trust
Few people realize that, even though they may have a modest estate, their families may owe thousands of dollars in estate and inheritance taxes because they own one or more life insurance policies with substantial death benefit. This is so because life insurance proceeds, while not subject to federal income tax, are considered part of your taxable estate and are subject to federal estate tax at rates from 34% to 48%. In addition, life insurance benefits are subject to state estate or inheritance tax.

The solution to this problem is to create an Irrevocable Life Insurance Trust (ILIT) that will own the policy (or policies) and receive the proceeds on your death. A properly drafted life insurance trust keeps the insurance proceeds from being taxed in your estate as well as in the estate of your surviving spouse. It also protects the trust beneficiaries from their own “excesses;” that is, against their creditors and in the event of divorce. Moreover, the trust also provides reliable management for the trust assets. Here is how the ILIT works.

You create an ILIT to be the owner and beneficiary of one or more life insurance policies on your life. You contribute cash to the trust to be used by the Trustee to make premium payments on the life insurance policies. If the trust is properly drafted, the contributions you make to the trust for premium payments will qualify for the annual gift tax exclusion (currently $11,000 per person, per calendar year), so you will not have to pay federal or any state gift tax on the contributions.

The life insurance trust typically provides that, during your lifetime, principal and income, in the Trustee's discretion, may be paid or applied to or for the benefit of your spouse and descendants. This allows indirect access to the cash surrender value of the life insurance policies owned by the trust, and permits the trust to be terminated if desired despite its being irrevocable. On your death, the trust continues for the benefit of your spouse during his or her lifetime. Your spouse is given certain beneficial interests in the trust, such as the right to income, limited invasion rights, and eligibility to receive principal. On the death of your spouse, the trust assets are paid outright to, or continued to be held in trust for the benefit of your descendants.

If you own life insurance with a significant death benefit, an ILIT may be of substantial benefit to you. Please call us to discuss this and other legal issues further.

(Copyright © 2004, all rights reserved. Provided by Martin L. Pierce, a Member of the Chattanooga office of Husch & Eppenberger, LLC. Martin is a Business and Tax attorney who is Certified as an Estate Planning Specialist in Tennessee and through the ABA-approved national professional and testing organization. He is also licensed in Georgia.

DISCLAIMER: This article provides general coverage of its subject area. It is provided free, with the understanding that the author, publisher and publication do not intend this article to be viewed as rendering legal advice or service. If legal advice is sought or required, the services of a competent professional should be sought. The author and the publisher shall not be responsible for any damages resulting from any error, inaccuracy or omission contained in this publication.)