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How to Reduce or Eliminate Your Estate Tax Cost
FAQs
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1. What does a life insurance trust do? An irrevocable life insurance trust lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones. It also gives you more control over your insurance policies and the money that is paid from them. (Back to Top) 2. What are estate taxes? Estate taxes are different from, and in addition to, probate expenses and final income taxes (which must be paid on any income you receive in the year you die). Some states also have their own death/inheritance taxes. Federal estate taxes are expensive - the rate is
46% in 2006, 45% in 2007 and 2008 - and they must
be paid in cash, usually within nine months after
you die. Since few estates have this kind of cash,
assets often have to be liquidated. But estate
taxes can be substantially reduced or even
eliminated - if you plan ahead. 3. Who has to pay estate taxes? Your estate will have to pay estate taxes if its net value when you die is more than the "exempt" amount set by Congress at that time. Here is the current schedule: Year of Death.........Estate Tax "Exemption" 4. What makes up my net estate? To determine your current net estate, add your assets then subtract your debts. Many people are surprised that insurance policies in which they have any "incidents of ownership" are included in their taxable estates. 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. 5. How does an insurance trust reduce estate taxes? 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. Let's say you are married, with a combined net
estate of $5 million, $1 million of which is life
insurance. With a tax planning provision in a
revocable living trust or will, you can protect up
to $4 million in 2006-2008 from estate taxes. But
if you die in 2006, your estate would have to pay
$460,000 in estate taxes on the additional $1
million ($450,000 in 2007 and 2008). With an
insurance trust, the $1 million in insurance would
not be in your estate. That would save your family
at least $450,000 in estate taxes. 6. What if my estate is larger than this? 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. 7. How does an irrevocable insurance trust work? 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. 8. Can I be my own trustee? 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. (Back to Top) 9. Why not just name someone else as owner of my insurance policy? If someone else, like your spouse or adult child, owns a policy on your life and dies first, the cash/termination value will be in his/her taxable estate. That doesn't help much. But, more importantly, if someone else owns the
policy, you lose control. This person could change
the beneficiary, take the cash value, or even
cancel the policy, leaving you with no insurance.
You may trust this person now, but you could have
problems later on. The policy could even be
garnished to help satisfy the other person's
creditors. An insurance trust is safer - it lets
you reduce estate taxes and keep control. 10. How does an insurance trust give me control? With an insurance trust, your trust owns the policy. The trustee you select must follow the instructions you put in your trust. And with your insurance trust as beneficiary of the policies, you will even have more control over the proceeds. For example, your trust could allow the trustee to use the proceeds to make a loan to or purchase assets from your estate or revocable living trust, providing cash to pay expenses. You could provide your spouse with lifetime income and keep the proceeds out of both of your estates. You could keep the money in the trust for years and have the trustee make distributions as needed to trust beneficiaries, which can include your children and grandchildren. Proceeds that stay in the trust can be protected from courts, creditors (even ex-spouses) and irresponsible spending. By contrast, if your spouse or children are
beneficiaries of the policy, you will have no
control over how the money is spent. If your spouse
is beneficiary and you die first, all of the
proceeds will be in your spouse's taxable estate;
that could create a tax problem. Also, your spouse
(not you) will decide who will inherit any
remaining money after he or she dies. 11. Are there other benefits to naming the trust as beneficiary of an insurance policy? Yes. If you name an individual as beneficiary of a policy and that person is incapacitated when you die, the court will probably take control of the money. Most insurance companies will not knowingly pay to an incompetent person, and will usually insist on court supervision. But if your trust is beneficiary of the policy, the trustee can use the proceeds to provide for your loved one without court interference. (Back to Top) 12. Who can be beneficiaries of the trust? You can name any person or organization you wish. Most people name their spouse, children and/or grandchildren. (Back to Top) 13. Where does the trustee get the money to purchase a new insurance policy? From you, but in a special way. If you transfer money directly to the trustee, there could be a gift tax. But you can make annual tax-free gifts of up to $12,000 ($24,000 if your spouse joins you) to each beneficiary of your trust. (Amounts may increase periodically for inflation.) If you give more than this, the excess is applied to your federal gift/estate tax exemption. Instead of making a gift directly to a
beneficiary, you give it to the trustee. The
trustee then notifies each one that a gift has been
received on his/her behalf and, unless he/she
elects to receive the gift now, the trustee will
invest the funds - by paying the premium on the
insurance policy. Each beneficiary must understand
the consequences of taking the gift now; for
example, it may reduce the trustee's ability to pay
premiums. 14. Are there any restrictions on transferring my existing policies to an insurance trust? Yes. If you die within three years of the date of the transfer, it will be considered invalid by the IRS and the insurance will be included in your taxable estate. There may also be a gift tax. Be sure to discuss this with your advisor. (Back to Top) 15. Can I make any changes to the trust? An insurance trust is irrevocable, so you can't make changes after it has been set up. Read your trust document carefully, and be sure it's exactly what you want before you sign. (Back to Top) 16. When should I set up an insurance trust? You can set up one any time, but because the trust is irrevocable, many people wait until they are in their 50s or 60s. By then, family relationships have usually settled - and you know whom you want to include as a beneficiary. Just don't wait too long - you could become
uninsurable. And remember, if you transfer existing
policies to the trust, you must live three years
after the transfer for it to be valid. 17. Should I seek professional assistance? Yes. If you think an irrevocable insurance trust would be of value to you and your family, talk with an insurance professional, estate planning attorney, corporate trustee, or CPA who has experience with these trusts. (Back to Top) 18. Benefits of Life Insurance Trust • Provides immediate cash to pay estate taxes and other expenses after death. • Reduces estate taxes by removing insurance from your estate. • Inexpensive way to pay estate taxes. • Proceeds avoid probate and are free from income and estate taxes. • Gives you maximum control over insurance policy and how proceeds are used. • Can provide income to spouse without insurance proceeds being included in spouse's estate. • Prevents court from controlling insurance proceeds if beneficiary is incapacitated. (Back to Top) |
There are 8 sections to FAQs:
• Living Trusts
• Estate Taxes
• Who Should Be Beneficiary of Your IRA
• Corporate Trustees
• Charitable Remainder Trusts
• Life Insurance Trusts
• The Duties and Responsibilities of a Successor Trustee
• Funding Your Living Trust
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