V—Life Insurance Trust
The trust is one of the most basic tools of estate planning. When made irrevocable and funded with life insurance, it accomplishes multiple objectives. For example, it can:
- Provide Creditor Protection
- Provide Income for a Family
- Provide Liquidity for Estate Settlement Costs
- Reduce Estate Taxes
- Avoid Probate Costs
- Provide for Management of Assets
- Maintain Confidentiality
- Take Advantage of Gift Tax Laws
DURING LIFETIME, it is possible for a grantor to establish a trust that will accomplish all of these objectives. The beneficiaries of such a trust are normally members of the grantor’s family and likely to be estate beneficiaries.
Once the trust is created, policies on the life of the grantor can be given to the trust. If no such policies are available, then the trustee would obtain the needed life insurance. In either case, funds are given to the trust, which, in turn, pays the premiums to the insurance company.
In order to take full advantage of the gift tax annual exclusion, the beneficiaries must have a limited right to demand the value of any gifts made to the trust each year. However, in order not to defeat the purpose of the trust, the beneficiaries should not exercise this right to demand. In this way, each year up to $17,000 per beneficiary, as indexed for inflation in 2023, can be given tax-free to the trust.
UPON DEATH, the grantor’s property passes to his estate. At the same time, the insurance company also pays a death benefit to the trust. If the trustee was the original applicant for and owner of the policies, or if the grantor lived for over three years following any gift of existing policies to the trust, the death benefit will be received free of federal (and, typically, state) estate taxes.
There are two ways the trustee can provide the liquidity to pay estate settlement costs. Either the trust makes loansto the estate, or the estatesells assetsto the trust. In any event, guided by specific will and trust provisions the beneficiaries can receive distributions of income and property.