Purpose: The purpose of a life insurance
trust is to avoid federal estate taxes on life insurance proceeds owned
or controlled by the decedent. Anyone who buys their own life
insurance, or has it provided by their employer, will usually
have the face value of the insurance included in their estate
for federal estate tax purposes. For information about federal estate
taxes, click here: Estate Taxes
Insurance can inflate the
size of an estate: For example, if you
have a house, stocks, and bank accounts that add up to $1,900,000,
you may believe that you do not have a federal estate tax problem.
However, if you also have $500,000 worth of life insurance provided
by your employer (and you are allowed to name the beneficiaries,
for example), it is considered part of your estate. Instead of
a $1,900,000 estate, you have a $2,400,000 estate, and estate taxes will be
due after you die (assuming you are not married and do not have other
deductions, such as charitable contributions).
How can estate taxes be
avoided? If the insurance is not owned
by the decedent or by his or her spouse, the insurance will not
be considered part of the estate. This can be accomplished by
setting up an irrevocable life insurance trust whose trustee buys the
insurance and pays the premiums for the insurance.
How does a life insurance
trust work? The trustor sets up the trust
and names a trustee, who will buy the insurance for the trust, using funds
contributed to the trust by the trustor. After
the trustor's death, the proceeds of the insurance are paid to
the life insurance trust, and then distributed to the beneficiaries
of the trust, who often are the trustor's children. If the trust
has been administered properly, the proceeds of the insurance
will be distributed free of federal estate taxes to the beneficiaries.
