What is a Life Insurance Trust?
Many people who are trying to put together an estate plan are unaware that life insurance can be included in your estate when you die. Depending on the size of the policy or policies, this could have significant estate tax repercussions. Also, you may be concerned that your policy beneficiary will be unable to properly manage the money that you are leaving, either because of age for other reasons. Thankfully, there are possible solutions to these problems, including the formation of an irrevocable life insurance trust (ILIT) to take over ownership of the insurance policy.
An ILIT is a trust that has specifically been set up to take over ownership of one or more life insurance policies. You can transfer ownership of an existing policy to the ILIT, or the trust can purchase a new policy directly.
With an ILIT, you must ensure that you do not have what is called “incidents of ownership.” Just transferring the policy to the trust is not enough to realize the tax benefits of the trust: you can’t retain the rights to change the policy’s beneficiary, to borrow against the policy, or to use the policy as collateral for a loan. This is why an ILIT is irrevocable: once you set it up, you can’t rescind it or make any changes.
Unlike with a living trust, you cannot serve as the trustee of an ILIT. Since the trust is required to be irrevocable, you may only fund it and make payments on the premiums for the policy, typically by making gifts to the trust that the trustee uses to pays the premium. That said, you will appoint the trustee. If you’re not sure about who to appoint, your estate planning attorney can help you make this important determination.
With an ILIT, the primary beneficiary of the insurance policy is the ILIT itself. All death benefits will be deposited into the ILIT when you die and the money will be held in trust for the benefit of the individuals you have named in the trust documents and distributed to them according to your detailed instructions.
The Difference Between a Will and a Trust
Whereas many use the terms “will” and “trust” interchangeably in common conversation, the fact of the matter is that when you are putting together an estate plan, they are two completely different concepts. Which one you choose will depend on your desires and goals for the future, which should be a primary topic of discussion between you and the estate planning professional you choose.
The major difference between a will and a trust is that a will must go through the probate process. Wills are the most common instrument in estate planning because they are very easy to create. Almost anyone can write a will, although an improperly drafted will – such as one created without the assistance of an estates and trusts attorney or other estate planning professional – is more likely to get bogged down in probate. Though wills are easy to draft, it is also easy to make mistakes with them. Poorly drafted wills are more likely to be challenged by your heirs or invalidated by the judge in probate court. If you die and the will you leave behind is deemed invalid, your assets will be distributed according to Arkansas intestacy laws. In other words, your final wishes will not be carried out as you intended.
Like a will, a trust ensures that your assets go to the people who you want to have them. The difference is that trusts do not go through probate. Once you fund a trust, the assets in the trust belong to the trust. With a revocable living trust, you can continue to retain complete control of those assets while you are alive, but upon your death, the trust will be managed, and assets distributed, by the trustees you have appointed without the input of the Arkansas probate court.
Potential Problems With a Life Insurance Trust
If you transfer your life insurance policy or policies into an ILIT and you die within three years of doing so, the IRS will still include the proceeds as part of your estate for tax purposes. This can be avoided in some cases by having the trust purchase the policy, but that may not always be possible, especially if the policy you currently own is substantial.
You will also need to make sure issues don’t arise with gift taxes or with the federal generation-skipping transfer tax, which comes into play when your beneficiaries are more than one generation removed from you, such as grandchildren. An experienced estate planning attorney will make sure your ILIT is properly drafted to avoid any problems.
An ILIT can help your loved ones receive the greatest possible benefit from your life insurance policy. If you’d like to discuss the advantages with an experienced estate planning attorney, contact Estate Planners of Arkansas today at 501-414-8965 for a free consultation.