Make sure you remember that this answer is supplied within the spirit of public education, not as legal guidance. In the event you require legal assistance for a specific situation, you should consult an attorney.

A life insurance trust is really a trust which is set up for the purpose of owning a life insurance policy. If the insured is the owner of one’s policy, the proceeds of your policy will likely be subject to estate tax when he or she dies. However, when he moves ownership to a life insurance trust, the profits will probably be entirely no cost of estate tax. (The takings will be exempt from income tax either way.)

Because of the current estate tax rate of 35%, a life insurance trust can save a lot of dollars in estate taxes. Nonetheless, you will discover many drawbacks to such an arrangement:

1. You cannot alter the beneficiary of the policy.

The insured must surrender control of the ability to alter the beneficiary of one’s policy (the trust itself will be the beneficiary). The trustee alone has that right, and the insured cannot serve as trustee of his own life insurance trust. Needless to say, the insured will designate the beneficiaries of your trust (as an example, his kids). But because this designation can’t be changed after the life insurance trust has been constructed, the insured will lack the freedom to deal with changed family members predicaments with this specific policy.

2. You cannot borrow from the policy.

The insured cannot borrow from the policy. If the trust makes it possible for him to borrow against the policy, he will be deemed to be an owner of one’s policy for estate tax purposes.

3. You can not transfer an existing policy to the trust — should you not live for at least 3 more years.

If the insured transfers a pre-existing policy to a life insurance trust and dies within the next three years, he might be treated as the owner of one’s policy and it will be taxed in his estate. Even if he survives yet another 3 years, he will have created a taxable gift in the quantity of your cash value of one’s policy (of course, this is normally better than having the whole face value exposed to estate taxes). If the life insurance trust takes out a new policy on the insured’s life, however, the insured will in no way be deemed to own the policy. Furthermore, no cash value will have built up , so no taxable gift will probably be created.

4. The life insurance trust must be irrevocable.

As soon as you set up and fund the trust, you cannot get the policy back. When you develop into uninsurable, you may be committed to this trust as your only life insurance.

5. Premium payments may well use up your estate tax exemption.

If the policy has not but endowed, you should discover an approach to pay the premiums without having to utilize your estate and gift tax exemption. Should you transfer securities to the trust to ensure that the trustee will have income with which to pay the premiums, the full value of your securities will be a taxable gift. In case you transfer money to the trust each year to pay the premiums, each transfer might be a taxable gift. However, you may be able to exempt these premium payments from gift or estate taxes by setting the life insurance trust up as a Crummey Trust (see the FAQ on Crummey Trusts). Then each and every premium payment could be sheltered through your annual gift tax exclusion, which is $13,000 (indexed for inflation) per trust beneficiary.

6. You must discover or hire a trustee.

The insured cannot serve as trustee of one’s life insurance trust. That indicates that he will have to locate or hire a third party trustee. Even so, several banks and trust businesses provide decreased fees for life insurance trusts simply because they involve basically no investing decisions.

Regardless of these disadvantages, many individuals come across that the tax saving potential of a life insurance trust is worth the price and hassle. It permits you to remove from your estate a significant asset that you are unlikely to want access to throughout your life. And it ensures that the life insurance proceeds go 100% to the beneficiaries, not the federal government.

To search for more interesting facts about life insurance trust, please have a look at what is a beneficiary .