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Reducing Or Eliminating Estate Taxes Through The Purchase Of Life Insurance
The purchase of life insurance through the use of an Irrevocable Life Insurance Trust (“ILIT”) can be an inexpensive way to pay estate taxes. With a life insurance policy being placed in the ILIT, it is no longer part of your estate and longer counted toward the value of your estate for estate tax purposes. Therefore the death benefits are not included in your Estate. These funds can be used to either pay the estate taxes or to make your beneficiaries whole for any assets transferred to a Charitable Remainder Trust. An Irrevocable Life Insurance Trust helps you to reduce or eliminate estate taxes so more of your estate can go to your beneficiaries. It also gives you more control over your Insurance policies and the proceeds that is paid from them.
An Insurance Trust has three components. The “Grantor” is the person creating the Trust. That is you. The “Trustee” manages the Trust. The “Trust Beneficiaries” you name will receive the Trust assets after you die. The Trustee is usually a corporate fiduciary or a trusted friend. Some people name their spouse or their adult children as Trustees. A Corporate Trustee will make sure the Trust is properly administered and the insurance premiums are promptly paid. 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 and then distribute the proceeds to the Trust beneficiaries that you have instructed.
The Insurance Trust reduces Estate taxes as the Trust owns the insurance policies for you. Since you personally do not own the insurance or have any “incidents of ownership” it will not be included in your Estate so your Estate taxes are reduced. Let’s say that you are married with a combined net Estate of $8 million in 2009, $1 million of which is Life Insurance. With the tax planning provision in a Revocable Living Trust, you can protect up to $7 million in 2009 from Estate taxes. If you die in 2009, your Estate will have to pay $450,000 in Estate taxes on the additional $1 million in life insurance. With an Insurance Trust, the $1 million in insurance would not be in your estate and your family would save $450,000 in estate taxes.
If your estate is larger than this, your estate will have to pay estate taxes after you transfer your insurance to a Trust. By having the Trust buy additional Life Insurance, you can use the Life Insurance to pay the additional estate tax cost. There are three very good reasons to do this. First, if the Trust buys the Insurance it will not be included in your Estate. The proceeds which are not subject to Probate or Income taxes will also be free from estate taxes. Second, the insurance proceeds are available immediately after you die, therefore your assets will not have to be liquidated to pay Estate taxes, rather you can you use the insurance proceeds. This is especially important for small business owners and farmers and real property owners. Third, Life Insurance can be an inexpensive way to pay estate taxes and other expenses so that you can leave more to your loved ones.
Assume the same example as above except a $9 million Estate. The $7 million is exempt and the $1 million which was placed in the life insurance trust is also exempt. This leaves an additional $1 million in assets which will be taxed. You could use that additional $1 million to purchase additional life insurance; thereby leveraging those funds to not only pay the estate taxes due but also to increase the size of your legacy for the benefit of your heirs.
After the Irrevocable Life Insurance Trusts documents are signed creating the Trust, the Insurance policies must be paid. The usual way in which the Trust operates is as follows: First, you as Grantor gift cash to the Trust. Second, the Trustee notifies the beneficiaries of the gift under the Crummey rules. Third, the beneficiaries acknowledge the gift but do not remove the monies from the Trust. Fourth, the Trustee uses the gift to pay the insurance premiums. Fifth, after you die the insurance proceeds are paid into the Trust and are available to pay estate taxes. The Trustee then distributes proceeds as you instructed.
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Meurer Law Offices
5347 S. Valentia Way, Suite 220
Greenwood Village, Co. 80111
303.991.3544
Estate Planning Attorney
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MEURER LAW OFFICES, P.C.
5347 South Valentia Way, Suite 220
Greenwood Village, CO 80111
Phone: 303-991-3544
