by “Your inability to predict the future should prevent you from being too controlling or too arrogant, but its not an excuse for failing to plan. We don’t know what’s going to happen, but that doesn’t mean we should put-off a meeting with a financial planner, or estate planner, or send a friend a birthday card.” —George Bischof, Estate Planning Attorney
An irrevocable life insurance trust can be a key tool for financial planning. There are two main benefits that make an insurance trust attractive: it can lower or eliminate estate tax exposure and provide robust asset protection.
Eliminate Estate Tax Exposure
An irrevocable life insurance trust has certain features that make it attractive in terms of estate planning. The main thing an insurance trust does is take the money out of the insured owners estate and put it into a trust where it has the potential of not being be taxed.
Many people think that there is no tax payable on their life insurance policy. This is partially true. Once paid-out, there is no income tax on the life insurance policy, regardless of who receives it, but the money will be subject to estate tax. Once the owner of the life insurance dies, their life insurance policy will be added to their taxable estate, and if the estate is large enough, the proceeds of that insurance policy may be subject to a small (state specific, 9%, 10%, 11%) state tax, or potentially a 40% federal tax if the estate is large enough.
Then at that point, after the estate tax has been paid, your beneficiary will receive the estate “tax-free.” But that’s cold-comfort if you have not done the right type of planning. In this case, having an irrevocable life insurance trust is a way to potentially lower or may entirely eliminate your estate tax exposure.
Provide Asset Protection
A life insurance trust can be a robust form of asset protection and planning. For example, say a husband has a life insurance policy around $2 million, then he suddenly dies; the $2 million policy is paid-out and is now in the hands of his surviving spouse. If she remarries and then goes through an ugly divorce, has a business bankruptcy or a car-accident, that $2 million insurance policy will be exposed to whatever happens to her. On the other hand, if that money had been in a life insurance trust–where the wife’s brother or the husband’s friend was the trustee for example, under a well-drafted trust agreement– the $2 million would have been protected.
An insurance trust can also protect your children’s legacy. For example, if a husband dies young, his $2 million dollars are now continually held in a trust for his surviving spouse and children. Then if the spouse ever remarries and has more children with her new partner, the husband who died young can have the satisfaction of knowing that at least posthumously his resources are there for his own children. If your objective is to provide a legacy for your children, an insurance trust may be a way to achieve that goal.