Reasons For An Irrevocable Life Insurance Trust
People buy life insurance for many reasons, and it offers some unique features that are not found in many other financial products. For example, leverage, especially in the early years of a policy, where you pay a small premium to lock in a large death benefit or the ability to time liquidity to an event .
Alternatives To Life Insurance For Funding A Trust
Life insurance is just one way to fund a trust. They can also be funded with cash, stock investments, business interests, real estate and even personal property such as art or other valuable collectibles.
While there are benefits to each funding mechanism, a life insurance policy is typically the most straightforward and inexpensive way to fund a trust.
Who Can Be A Beneficiary Of A Life Insurance Policy In Trust
It is up to the life insurance holder to decide who the beneficiaries will be. Theyre usually family members or friends but it can be anyone youd like your life insurance money to go to if you die.
You could also choose a charity or an organisation to name as a beneficiary and there isnt a limit to the number you can have. Unless you have an absolute trust, the beneficiaries can change as well. This can happen if you divorce and remarry, for example, or if you have children.
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Irrevocable Life Insurance Trusts What They Are And Why They Are Great
Lets start with a brief trust primer. Virtually all trusts can be identified as one of two types. A Revocable Trust, or an Irrevocable Trust. Each is exactly what it sounds like. A Revocable Trust may be revoked or terminated after its creation, generally by the person who created it. Conversely, an Irrevocable Trust may generally not be revoked after its creation.
What we will discuss is this article is a Life Insurance Trust what they are, their general purposes, benefits and their tax structure. Most commonly they are irrevocable and are referred to as an Irrevocable Life Insurance Trust or ILIT. However, there are instances where a revocable life insurance trust might be used. Well talk about why ILITs are generally irrevocable below.
While there are countless reasons or scenarios in which an ILIT might be beneficial, some of the most common reasons to create an ILIT as part of ones estate plan are as follows::
3) To provide replacement assets. Replacement assets can mean several things. It can mean the replacement of the income that would be lost by virtue of the death of the insured. It can also mean the replacement of assets that might be gifted to charity under a Will or during life. .
5) To accomplish estate tax savings. I dont generally like to use the term loophole when discussing tax law. But heres the thing: ILITs are one of the few remaining loopholes in estate tax planning.
Lets discuss how it works.
What Is A Flip Crut
Some people can use this type of gift planning tool to meet both their financial and philanthropic goals in a way that standard unitrusts or gift annuities cant do.
A flip CRUT is a type of charitable remainder trust that is allowed by federal tax law since it meets all of the same rules as a standard CRUT. In a standard trust, the income beneficiary will get the trusts net income, or the payout percentage set out in the trust document, whichever is less.
In a standard trust, the income beneficiary will get the trusts net income, or the payout percentage set out in the trust document, whichever is less. In the year after the triggering event, the trust turns into a standard CRUT, which means that payments are made to the beneficiary based on the percentage that was set.
This percentage is added to the value of the assets in the account each year to figure out how much money the income beneficiaries will get in the next year.
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What Is An Irrevocable Life Insurance Trust
Trusts are often used in estate planning to protect assets from taxes and transfer wealth to your heirs. Irrevocable life insurance trusts are sometimes incorporated into an estate plan so that a life insurance policy doesnt increase a taxable estate.
With an irrevocable life insurance trust, the trust owns the policy, removing any incidents of ownership. Only the policyholder can pay life insurance premiums. So you fund the trust, and the funded trust then pays the life insurance premiums.
With the trust as the policyholder, the money is no longer considered a part of your estate and therefore does not increase the value of your estate for tax purposes. It also wont be subject to probate and your heirs can receive the life insurance death benefit in its entirety.
The trust is also the beneficiary of the life insurance policy. When you die, the death benefit will pay into the trust, which will then distribute it according to your wishes.
How Can You Terminate An Irrevocable Life Insurance Trust
To unwind, or terminate an ILIT, strict criteria must be met.
- One method is to substitute the value of the life insurance policy inside the trust with an equivalent amount of cash. The life insurance policy then reverts back to the individual owner and the ILIT becomes a grantor trust instead.
- A second method is to simply stop paying premiums to the policy, allowing it to lapse. This is usually only cost-effective if the ILIT holds a term life policy that does not have any accumulated cash value.
- If the insured is older, it is possible to sell the policy inside the ILIT via a life settlement arrangement. In this case, the life settlement buyer becomes the new policy owner and beneficiary. In return, the trust receives a lump-sum cash payment. Note that this may only be an option if the insured is 60 years of age or older.
- Seeking a legal injunction to terminate the ILIT is a more difficult option, but can be achieved if it can be proven that the ILIT was created under false pretenses. In other cases, the trust may be written giving permission to the trustee to terminate the trust under particular circumstances. This would often also require consent by both the grantor and the beneficiaries.
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How Does An Insurance Trust Work
An Insurance Trust is fairly straightforward to set up and operate.
Once its created, the Grantor funds it by putting their life insurance policy into it. This means that the Trust in essence now owns the policy . The Trust is a legal entity that exists outside of a Grantors estate, and so the Trust is exempt from overall estate taxes.
When the Grantor passes away, the life insurance benefit is paid out to the Trust rather than to an individual beneficiary. The Trustee pays any expenses or taxes that may be required . A good example of a common expense that might be occurred here could include legal fees relating to the life insurance policy and the Trust execution.
In the final step, the Trustee will distribute the life insurance payout to the named final beneficiaries of the Trust. This is done following the explicit guidelines stated in the Trust documents.
How To Make A Life Insurance Trust
If you think a life insurance trust is the right type of trust for you, speak with qualified estate planning attorneys to get started. Life insurance trusts are complex legal documents, and a lawyer can walk you through the specifics of the trust and assist you in drawing up the document. Contact trusts attorney Michelle Lanchester today, and she can helping in setting up a trust to support your loved ones.
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Use Of Revocable Trust To Hold Life Insurance
With the passage of the Act in 2017, the estate tax exemption amount was increased to 11 million dollars, indexed for inflation for individuals. This amount will sunset in 2025, meaning it will revert back to 5 million index for inflation in 2025 unless the law is changed or the current law is made permanent.
Seeing that the estate tax exemption is so high, and even if reduced to the previous amount, the majority of individuals fall well below the threshold. Here is where the Revocable Trust comes into play.
The revocable trust can be used to own the life insurance or be the beneficiary of the life insurance. The benefit of the revocable trust holding the life insurance is that if you were to become incapacitated, your successor trustee will be able to keep administering the life insurance policy on your behalf.
In any event, you will want the revocable trust to be the beneficiary of the life insurance so that the death benefit proceeds are distributed to your successor trustee for the funds to be administered according to your trust.
A revocable trust gives you a lot of flexibility and control over an irrevocable trust. You can amend the trust at any time or even revoke it. Unlike an irrevocable trust, you can file the taxes for the assets in a trust under your own social security number, you will not need a separate taxpayer ID.
Managing Distribution Of Your Payout
You may not want your beneficiary to receive a lump sum because you feel they are unable to manage their finances, or theres a fear theyll deplete a large-sum payout by buying unnecessary goods, through gambling, or a host of other pursuits you didnt intend to support or encourage.
A trust can turn the lump sum payment into a regular allowance. The trustee would be responsible for managing the total capital, so the beneficiary doesnt have to worry about investing it properly. The trust document would further dictate how to pay out the money. However, there are certain cases and ways a beneficiary can end a trust and receive whatever capital is left. This often involves applying to court or there may even be a predetermined end date fot the trust at which point the beneficiary could receive the remaining proceeds.
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Irrevocable Trusts And Estate Taxes
The cost to set up irrevocable trusts through a major law firm runs between $2,000 and $5,000, primarily because the permanency of such a trust and the amount of upfront work and thought that must go into getting it right the first time.
Its relatively easy to make a change in a revocable trust. But its much more complicated with an irrevocable trust.
When you place your life insurance policy in the trust, you must designate a trustee to manage it. The trustee can be a relative, but because of the legal requirements and possibly sensitive communications for which the trustee is responsible, many estate owners prefer to hire a trust management company, bank, lawyer or even an insurance company.
Many people who set up irrevocable life insurance trusts intend their beneficiaries to use death benefits to pay the taxes on a large estate. Set up properly, the trust can cover the tax bills of an estate.
How To Set Up A Trust For Life Insurance
To set up a trust youll need the following participants
- The settler or donor this is the person who is placing their assets into a trust.
- Trustee the person or people who are legally appointed to look after the assets in a trust. Often the trustee is someone who is known and trusted by the settler, and who is likely to live longer than the donor.
- Beneficiary those who will receive the proceeds of the trust upon the death of the settler.
Once youve decided who the trust participants will be, search the market to find a provider that offers the best rates and terms. An expert financial advisor can do this legwork for you, make the process straightforward, and give you peace of mind.
Make an enquiry and well match you with an advisor to discuss your options.
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Life Insurance And Wills
For assets included in your will, you will have to get probate granted before they can be distributed. But a life insurance trust deed acts as a will for the funds placed into the trust, making sure the funds go directly to your beneficiaries without the need for going through a probate for that part of your estate.
A life insurance policy thats been written into trust with a trust deed will only require a death certificate before making the payout. This speeds up the process of passing the funds on to your loved ones, saving some time and hassle.
Should You Put Your Trust In A Life Insurance Trust
Planning your legacy to loved ones is important, but it isnt always easy.
You may have purchased insurance and written a will to ensure some financial security for your loved ones, but how can you protect that money once youre gone?
A life insurance trust lets you control how funds are distributed after death, and can reduce or avoid estate taxes. But they arent necessarily the right choice for everyone.
For large estates, an irrevocable life insurance trust can limit the tax burden for heirs giving you control over how the proceeds of your policy are spent and who will inherit them. It can also provide much needed cash if your estate is mostly made up by hard-to-sell assets like real estate.
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Putting Life Insurance In A Trust
One benefit of a trust is that it allows you more control over how the assets in it are used. You can have the money distributed over time as a trust fund, or only have the trustee disburse money only under certain conditions or purposes .
Life insurance proceeds are typically paid all at once to the named beneficiary, after which you have no say over how the money is spent. However, if you have a living trust you can direct the life insurance death benefit to be paid to the trust, and then distributed to the trust beneficiaries. This helps to prevent the life insurance proceeds from becoming part of the probate estate and allows you to manage how the funds are used from beyond the grave. The trustee will make sure the trust beneficiaries get the proceeds according to your terms.
Many people choose to set up a trust for a minor child so it can hold onto assets, or a large sum of money, until they reach a specific age. You can even limit the amount of money they receive, which can be handy if you’re worried about their spending habits.
Moving Out Of The Estate
A life insurance trust lets you transfer ownership of a life insurance policy so you no longer own it directly. That way the proceeds will not be added to your estate, lessening the estate tax burden for your heirs. Heres how it works.
An irrevocable trust names someone else as the trustee. This gives up control over the policy, but not before deciding a few key things, such as who the beneficiary will be, how premiums will be paid and how benefits will ultimately be paid out.
If individuals have specific ideas about how the proceeds of the policy should be usedincome for a spouse, education for children or grandchildren, gifts to a favorite charity, and so onthey can provide specific instructions.
For the trust to be valid, it must meet these three conditions:
- It must be irrevocable.
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Peace Of Mind For Your Legacy
An Irrevocable Life Insurance Trust can build greater control into your estate planning, allowing you to decide exactly when, where, and to whom your assets will be distributed after youre gone. By removing ownership and control of a life insurance policy from an estate, an ILIT shelters your property from creditors and avoids estate taxation of life insurance death proceeds, freeing up funds to help meet liquidity and survivor income needs.
With an ILIT funded with life insurance products from Principal® and serviced by Principal Trust Company, you can feel confident that your estate plan is in trustworthy hands.
- Ensure that your assets will be distributed according to your wishes to minimize financial burdens and protect against disputes among your beneficiaries.
- Let Principal Trust Company work with your financial professional and attorney to help take the worry out of estate planning.
- Leverage unique Delaware tax advantages, including maximum privacy, strong asset protection, and perpetual duration, no matter where you live.
Other Potential Estate Planning Issues
Trusts can solve additional pain points for beneficiaries, but you have to be careful to make sure it all works out as planned without unintended consequences. For example, in some cases, benefits could increase someone’s assets enough that he or she could lose out on government benefits like Medicaid.
This is where financial advisors and tax experts are even more important. If you have any doubts working with a life insurance trust, consider working with an expert it can save you and your family significant stress and money down the road.
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Types Of Irrevocable Life Insurance Trusts
There are two kinds of ILITs:
- Funded ILIT: This is a trust funded with the insurance policy plus additional assets that can be used by the trustee to pay premiums. The downside of this arrangement is the possible gift tax consequence of contributing the additional assets to the trust.
- Unfunded ILIT: This type of trust is funded by the life insurance policy only, and no additional assets. Each year, the grantor must make annual contributions to the trust to provide the funds needed for the trustee to pay the premiums.