LIFE INSURANCE proceeds are almost always income-tax-free to the beneficiaries. But will estate taxes be owed? This is an issue for a small fraction of estates. If it is, you might consider an irrevocable life insurance trust. The insurance proceeds could then be used to cover estate taxes owed on other assets. Alternatively, the proceeds might provide an inheritance to children who don’t want to be involved in the family business, thus avoiding the need to sell the business, possibly in a rushed sale at an unfavorable price.
Why use a trust to hold life insurance? If you own a policy when you die, the proceeds could be subject to estate taxes. But if insurance on your life is owned by somebody else—or some other entity, such as a trust—no estate taxes are owed.
If you buy life insurance within a trust, you might pay the premiums by making use of the annual gift-tax exclusion, which is $15,000 in 2019. To make use of the exclusion, your attorney will need to create a trust with so-called Crummey powers. That means the beneficiaries have the right to withdraw the money gifted—a right you hope they don’t exercise.
If you transfer an existing policy into the trust, you need to live another three years beyond the date of the transfer for the change of ownership to be effective for estate tax purposes. Alternatively, you might cancel your current insurance and have the trust buy a new policy, assuming it makes financial sense and you can pass the necessary medical exam.
The tax advantages of life insurance are impressive, but so too are the premiums, especially as you get older. Still, for wealthy families facing estate taxes, it might be worth paying those premiums. If you’re married, you may be able to trim the premiums by using your irrevocable life insurance trust to purchase second-to-die life insurance, which doesn’t pay out until the second spouse in a couple dies.
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