Not if you want the tax advantages we’ve explained. Some people name their spouse and/or adult children as trustee(s), but often they don’t have enough time or experience. Many people choose a corporate trustee (bank or trust company) because they are experienced with these trusts. A corporate trustee will make sure the trust is properly administered and the insurance premiums promptly paid.
An insurance trust has three components. The grantor is the person creating the trust — that’s you. The trustee you select manages the trust. And the trust beneficiaries you name will receive the trust assets after you die.
The trustee purchases an insurance policy, with you as the insured, and the trust as owner and (usually) beneficiary. When the insurance benefit is paid after your death, the trustee will collect the funds, make them available to pay estate taxes and/or other expenses (including debts, legal fees, probate costs, and income taxes that may be due on IRAs and other retirement benefits), and then distribute them to the trust beneficiaries as you have instructed.
If your estate will still have to pay estate taxes after you transfer your insurance to a trust, you can reduce your estate tax costs — by having the trust buy additional life insurance. Here are three very good reasons to do this:
1. If the trust buys the insurance, it will not be included in your estate. So the proceeds, which are not subject to probate or income taxes, will also be free from estate taxes.
2. Insurance proceeds are available right after you die. So your assets will not have to be liquidated to pay estate taxes.
3. Life insurance can be an inexpensive way to pay estate taxes and other expenses. So you can leave more to your loved ones.
The insurance trust owns your insurance policies for you. Since you don’t personally own the insurance or have any incidents of ownership, it will not be included in your estate — so your estate taxes are reduced. (There is a three-year rule for existing policies, which is explained later.)
With the exemption at $5 million, you may not need the estate tax savings right now. But it’s important to understand how this works, because the exemption may be reduced as soon as 2013 and the value of your net estate may increase substantially by the time you die.
Let’s say you are married, with a combined net estate of $3 million, $1 million of which is life insurance, and both you and your spouse die when the estate tax exemption is $1 million and the top tax rate is 55%. A tax planning provision in a living trust or a will could protect up to $2 million from estate taxes. But your estates would have to pay $435,000 in estate taxes on the additional $1 million. With an insurance trust, the $1 million in insurance would not be in your estate. That would save your family $435,000 in estate taxes.
To determine your current net estate, add your assets then subtract your debts. Insurance policies in which you have any “incidents of ownership” are included in your taxable estate. This includes policies you can borrow against, assign or cancel, or for which you can revoke an assignment, or can name or change the beneficiary. You can see how life insurance can increase the size of your estate and the amount of estate taxes that must be paid.
Your estate will have to pay federal estate taxes if its net value when you die is more than the exempt amount set by Congress at that time. In 2019, the federal estate and gift taxexemption is $11.4 million and the tax rate is 40%. Some states have their own death or inheritance tax, so your estate could be exempt from federal tax and still have to pay state tax.
Estate taxes are different from, and in addition to, probate expenses and final income taxes which are due on the income you receive in the year you die. Federal estate taxes are expensive (historically 45-55%) and they must be paid in cash, usually within nine months after you die. Because few estates have the cash, it has often been necessary to liquidate assets to pay these taxes. But if you plan ahead, estate taxes can be reduced or even eliminated.
An irrevocable life insurance trust gives you more control over your insurance policies and the money that is paid from them. It also lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones.
Yes. If you think a charitable remainder trust would be of value to you and your family, speak with a tax-planning attorney, insurance professional, corporate trustee, investment adviser, CPA, and/or favorite charity. Be sure an attorney experienced in CRTs prepares the documents.