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What is a Life Insurance Trust?

Estate Planners | Monday, April 25th, 2011

When planning an estate, many people assume that if they have adequate life insurance coverage that their heirs will be well provided for. This is not always the case as federal estate tax can eat as much as fifty-five percent of the wealth of your estate before your heirs receive a dime. The life insurance trust is a type of trust that is established specifically for the purpose of owning life insurance. If the owner of the life insurance policy is also the insured, the proceeds of the insurance policy will be subjected to the federal estate tax when the insured passes away. However, if insured transfers ownership of the policy to a life insurance trust, the insurance policy proceeds will be free of estate tax burdens and naturally free from income tax regardless. With the current estate tax rate of forty-five percent, the action of establishing a life insurance trust can save a significant amount of money in estate tax.

Nonetheless, there are some distinct disadvantages to establishing a life insurance trust that must be considered when planning your estate, including:

* The life insurance trust will, in effect, be the beneficiary of the life insurance policy. If you establish a life insurance trust, you will give up your right to change the beneficiary, obviously. The trustee of the trust does have that right, but you cannot be the trustee for your life insurance trust. Keep in mind, however, that you will be able to designate the beneficiaries of the trust, but the beneficiaries that you designate cannot be modified or changed once the trust is established, and you will lack any flexibility for making changes if your family circumstances change.

* Unlike traditional insurance policies, you will not be able to borrow against a life insurance policy that is transferred to a life insurance trust. If the trust is set up to allow for you to borrow against the insurance policy, you will be deemed the owner of the policy for estate tax purposes.

* You cannot transfer an existing and current policy to a life insurance trust, unless you live for an additional three years. If an existing policy is transferred to a life insurance trust and you die within the next three years, you will be considered the owner of the policy and it will taxable to your estate. If you do survive longer than three years, you will have made a taxable gift for the amount of the cash value of the insurance policy. Regardless, this is typically advantageous when compared to the entire face value of the policy subjected to federal estate tax.

Despite some drawbacks to the life insurance trust, it is a great and money-saving tool for many folks. The life insurance trust is a viable estate planning tool that may be very beneficial to you as you plan your estate. Discuss the life insurance trust and other trusts with your local estate planner to determine which trust is best for your situation and estate objectives.

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