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Life Insurance Trust for Estate Planning

What is a life Insurance Trust?

A Life Insurance Trust is a trust designed to be the owner or beneficiary of your life insurance. There are two types of trusts that are used to hold life insurance: 1) irrevocable trust or 2) revocable trust.

Under a revocable trust, you can have a lot of flexibility and control, but the death benefit value of the life insurance will be included in your gross estate for estate tax purposes.

With irrevocable trusts, assuming that you are not the trustee and have no significant control, the assets in the irrevocable trust will not be included in your gross estate for estate tax purposes.

I will cover both trusts in more detail below.

Use of Irrevocable Life Insurance Trust

Prior to the 2017 Tax and Jobs Act (the “Act”), Irrevocable Life Insurance Trusts (“ILIT’s”) were used to be the owner and beneficiary under your life insurance. The reason for the use of the ILIT prior to 2017 is due to the estate tax upon death. Prior to the Act, the estate tax exemption (unified credit) was 5.4 million dollars. 

For estate tax purposes, the value of the death benefit is counted towards the calculation of the estate tax. Therefore, if you had a 2 million dollar policy, the death benefit value would be included under your gross estate and in many situations, that would have made you exceed the 5.4 million dollar threshold. 

The estate tax is 40% of your assets over the exemption amount. You can see how people would want to reduce their gross estate in order to reduce or avoid estate taxes.

For legal and for tax purpose, the ILIT is a separate taxpayer. Therefore, at your death, the value of the ILIT will not be included under your gross estate because you did not own it personally.

In order for life insurance to not be included under your gross estate you must not have incidents of ownership. The ILIT solves that problem by having the ILIT own the life insurance policy and be the beneficiary under the policy. However, for this strategy to work, you must not be the Trustee of the ILIT or have provisions that would cause you to have incidents of ownership. 

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.

If you are well under the estate tax exemption amount then having a revocable trust to hold life insurance purposes its one of the best tools you can have as it provides the most flexibility and you will not have to pay estate tax in the first place. 

Benefits of owning life insurance in a trust for estate planning purposes

For most people wanting to leave a legacy, the two assets that come top-of-mind are life insurance and a home.

Although nobody wants to think about death, life insurance provides a lot of benefits when it comes to setting up your estate plan. Having life insurance in a trust provides a multitude of benefits which I will briefly outline below:

Management and control of assets

A life insurance trust provides for the management and distribution of the life insurance funds. The income and the principal of the trust can be distributed according to your wishes.

If the proceeds of the life insurance are distributed outright to your beneficiaries, you will have no control of how they spend the funds. Therefore, having a life insurance trust may be beneficial to insurance that the proceeds last for a reasonable time and are used properly.

Protection from Creditors

Under most circumstances, proceeds from life insurance is protected under state law. Your creditors will not be able to attach to any proceeds of the life insurance.

The advantage of having a life insurance trust is that if your beneficiaries have creditors, the creditors may be able to attack any distributions. Proper provisions can be put in place to protect your beneficiaries from their creditors or any unforeseen divorce. 

Reduce federal estate tax

If the federal estate tax is a concern, the use of the ILIT can be used to reduce any estate tax liability. It is particularly important to have a consult with an estate planning attorney well versed with federal tax law in this circumstances.

Maintain or qualify for governmental benefits

If you have a beneficiary that is disabled and is receiving governmental assistance like Medicaid, then having a life insurance trust with special needs provisions is extremely important.

The life insurance trust can be set up in a way to protect the interest of the special needs person to maintain his or her government benefits. 

Avoid Guardianship for Minors

If a minor in Florida receives over $15,000 then a guardianship will have to be established for the benefit of the minor. Guardianship can be expensive and court intrusive.

If the life insurance trust is used, when you pass away the trust will be beneficiary and the proceeds can be administered for the benefit of the minor without any court intervention.

Avoid Probate Court

Although a life insurance policy avoid probate court if it has a properly designed beneficiary, it is my experience that a lot of people fail to keep their beneficiary updated. 

You may have your parents as beneficiaries or your spouse, but then one of your parents may pass away or you get divorced and your life insurance policy has no contingent beneficiary. At that point your life insurance policy will needs to get probated in order to receive the proceeds.

However, if you create a life insurance trust, the trust if drafted properly, will have contingent beneficiaries, and may have multi-generational provisions. Meaning that your child can be the beneficiary of the trust, but if your child passes away, then his or her interest will pass to your grandchildren.

Liquidity

The last major benefit that a life insurance policy offers for estate planning purposes is liquidity. If you a property or a business, it may be months before your beneficiaries are able to either sell the asset or receive benefits from it.

Having the life insurance policy allows your beneficiaries to immediately start ripping the benefits of the proceeds.

Final Thoughts

Whether you choose to create a revocable life insurance trust or an irrevocable life insurance trust, using trusts to own and benefit from the life insurance is a valuable choice.

Having life insurance trusts can be more beneficial than detrimental. 

If you have life insurance and you are thinking of setting up your life insurance trust my office is here to help you. I offer free consultations and can help you answer all the questions you may have.

Hope to see you soon.

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