Irrevocable Life Insurance Trust

In the Funding the Estate Tax section, we discussed the options of transferring ownership of your life insurance policy to remove the death benefit from your estate to provide your beneficiaries with tax-free proceeds. This page will review another method to achieve the same result, with slightly different provisions – creating an irrevocable life insurance trust.

By transferring the ownership of your life insurance policy to a trust, the payout to your beneficiaries will not be included in the taxable estate. The reason being that since the policy will be owned by the trust, you are not the owner, and it is removed from your taxable estate.

Keep in mind that this type of arrangement is suited for the wealthy – those with assets in excess of $2 million. If your estate’s value is less, your beneficiaries will not have to pay taxes on the death benefit.

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Transferring Life Policy Three-Year Rule

Similarly to transferring ownership, the IRS’s “three-year rule” applies. This states that the life insurance policy must be transferred to the trust within three years of your death. If you die before the three years have passed, the policy becomes part of your estate and is subject to taxes.

Considerations for an Irrevocable Life Insurance Trust

Overall, the biggest drawback of an irrevocable life insurance trust is that you lose control over the policy and will be unable to make changes. Additionally, trusts are generally complex and require additional money to set up and maintain. Keep in mind that:

• Any assets you put into the trust must remain there.
• Beneficiaries cannot be added or removed.
• The appointed trustee can only be changed if that person agrees to resign.
• Irrevocable trusts allow you to enjoy tax savings since the beneficiary of the trust pays the income taxes on any earnings.
• You lose the option of borrowing against the cash value.

Irrevocable Life Insurance Premium Payments

Your life insurance premiums still need to be paid on time, even though the policy is in a trust. Generally, you make a gift to the trust and that money is used to pay the premiums. These gifts can be made tax-free up to $12,000 per beneficiary annually.

Appointing an Irrevocable Life Insurance Trustee

Due to the complex nature of trusts, individuals are generally not chosen as a trustee, rather, the best course is to appoint your bank trust department, lawyer, or accountant.

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