If you own life insurance policies at your death, the proceeds will be included in your taxable estate. Ownership is usually determined by several factors, including who has the right to name the beneficiaries of the proceeds. One way around this problem is to have a properly structured irrevocable life insurance trust (ILIT) own the policies.
An ILIT could save significant estate taxes on the insurance proceeds. For example, a $5 million life insurance policy owned by an ILIT instead of by you, individually, could reduce your federal estate taxes by as much as $2 million if the entire amount is subject to estate tax and the rate is still 40%. An ILIT will also shelter the life insurance proceeds from any applicable state estate tax.
How does this work? The trust owns the policy and pays the premiums. When you die, the proceeds pass into the trust and aren’t included in your estate. The trust can be structured to provide benefits to your surviving spouse and/or other beneficiaries.
ILITs have some inherent disadvantages as well. One is that you lose some control over the insurance policy after the ILIT has been set up. After you transfer a policy to the trust, you can no longer change or add beneficiaries; assign, surrender or cancel the policy; or borrow against or withdraw from the policy’s cash value.
If life insurance is part of your estate plan and you’re concerned about estate taxes, contact us to learn more about ILITs.