For many people, life insurance is a simple thing; you buy a policy so that your family will get some financial help after you die. However, in many cases, life insurance can be a useful tool when it comes to estate planning. A traditional life insurance policy will pay out after your death, but an irrevocable life insurance trust can be much more useful. It all depends on your estate planning goals and the type of assets you have.
What is an Irrevocable Life Insurance Trust?
An irrevocable life insurance trust can be created during your lifetime. The trust owns the insurance policy on your life via a transfer of ownership of an existing policy. Basically, this separates the policy from the estate and provides some protection against taxes and debts. In other words, you don’t own the life insurance policy, the trust does.
This type of life insurance trust can help your family pay off estate taxes or even avoid them altogether. Because a life insurance policy is included among your assets for calculation purposes, it can increase the value of your estate which can then increase the total estate taxes. In other words, life insurance policies are taxable. An irrevocable life insurance trust can shelter these assets so your estate is appraised without the value of the life insurance policy.
Who Needs an Irrevocable Life Insurance Trust?
The main advantage of an irrevocable life insurance trust reducing the taxes on your estate. If your life insurance policy puts your estate over the federal limit (currently $11.2 million)
An irrevocable life trust might be a good idea if you are trying to manage the estate taxation on your life insurance policy. It is also a good way to provide income to your heirs. It can provide your heirs with life insurance coverage after your death and can also allow a trustee to distribute death benefits from a policy without waiting for probate. Finally, having an irrevocable life insurance trust means that less liquid assets may not need to be sold off to cover costs.
How Does an Irrevocable Life Trust Work?
If you have an irrevocable life insurance trust, the proceeds of your life insurance are not legally considered your property. Therefore, they are not included in the calculation of your estate. The trust’s ownership in the policy is irrevocable, but it should provide some direction as to how the payments should be made to the beneficiaries. It’s important the trust should take care of necessary costs (medical and funeral expenses) as well as other debts (probate costs and taxes).
Like any other trusts, irrevocable life trusts have a grantor, a trustee and beneficiaries. You are the grantor, and you will need to get a trusted person to be the trustee to administer the payments. The trustee then has a fiduciary duty to manage the trust and keep the best interests of the beneficiaries in the mind. It is possible to remove your life insurance policy from an irrevocable life insurance trust, but it takes planning.
Setting up a good irrevocable life insurance trust will probably require the assistance of an attorney and maybe also a financial planner. You may also need to designate a financial institution that manages the funds. Because almost all life insurance trusts are irrevocable (i.e. permanent) it’s important to make the decision carefully.