Why Irrevocable life insurance trust is so important if you have children:

The need for life insurance in the case of a couple with children is obvious.  If the family breadwinner dies prematurely, the life insurance proceeds will be available to support the family, and if both parents die, the insurance is there to support their children.  Understanding this concept is not difficult, however, getting all the insurance to pass to your beneficiaries without being reduced by a 50% estate tax, requires more thought and planning.

In a typical case, a married couple with young children will insure the life of the spouse who generates the bulk of the family income. The surviving spouse will be designated the beneficiary of the life insurance.  As such, if the insured spouse dies, the survivor receives the death benefits and will be able to continue paying the mortgage and feeding the kids.  On the other hand, what if both parents die?  Who then should be beneficiary of the life insurance?  Most often, the parents will name the children as secondary beneficiaries.  This, however, will not only allow your children to access the money at age 18, but the life insurance proceeds could be reduced by 50% through the payment of estate tax.

An irrevocable life insurance trust offers a solution.  Instead of owning the life insurance yourself and naming your children as secondary beneficiaries,  a trustee of an irrevocable life insurance should be named as the owner and beneficiary.  Through this arrangement, estate tax is avoided on the life insurance money when you die.  Your children can then receive the entire amount of money, without it being reduced by 50% through the payment of estate tax.  Rather than allowing your children to access the money at age 18, it can be held in trust  for their benefit.  The money will be controlled and managed by the person you designate as trustee under your direction as stated in the trust agreement.

The Attributes of a Life Insurance Trust

Irrevocable:  A life insurance trust is irrevocable.  After it has been established none of its terms can be changed.

Trustee:  As with all trusts, a trustee is required for a life insurance trust. The trustee can be an individual or a financial  institution.  While you cannot be the  trustee,  and in many cases it is inadvisable to have your spouse serve as trustee, a friend or family member can serve.

Obtaining or Transferring Life Insurance:  If you are obtaining a new life insurance policy, the application should be made by the trustee of the trust, rather than by you as an individual.  If you have an existing life insurance policy, it can be transferred into a trust.  However, in order to avoid the estate tax, you must survive for at least three years after the transfer.

Ownership/Beneficiary:  The trustee of the trust will be both the owner and the beneficiary of the life insurance.  This means that at your death the life insurance proceeds will be paid into the trust.  The trustee will control it in accordance with the  terms of the life insurance trust.

Paying the Premiums:  The trustee will need to make the insurance premium payments to the life insurance company.  Because the trust will not likely have any funds to make the premium payments, you will need to transfer funds to the trustee so that he or she can pay the premiums.  Because these payments to the trust are gifts (and thus subject to gift tax), the beneficiaries must be given a ACrummey Power@ so that the gifts are tax free.  This Crummey Power will be explained further below.

Trust Beneficiaries

You will need to choose the beneficiaries of the trust who will ultimately receive the life insurance proceeds.  The beneficiaries must be chosen when you set up the trust and they cannot be changed later.  Often the beneficiaries of a life insurance trust are the same beneficiaries you would have under your will or living trust.  If you decide to include your grandchildren as beneficiaries, you will need to take into consideration the effect of the Generation Skipping Transfer tax (a tax which is assessed on transfers that skip a generation).

Distribution of the Life Insurance Proceeds

Generally, no distributions are made from the trust until after your death and the life insurance money is collected.  The trust can provide for the immediate distribution of the money or direct that the proceeds be held in trust.  Holding the assets in trust is particularly useful with young beneficiaries.  While in trust, the money can be managed and invested by the trustee for the benefit of the named beneficiaries.  The trust can be for the benefit of one or many beneficiaries.  Until outright distributions are made, the trustee can be given the power to spend money for the beneficiaries’ needs, such as education, medical care, buying a home or a business.  Basically, the trustee acts as the parent financially.  The trust can also allow for partial or lump sum distributions when a beneficiary reaches a certain age (such as 50% at age 25 and 50% at 30).

Life Insurance Proceeds – Money to Pay Estate Tax

The proceeds of the insurance policy will also provide money to pay any tax.  If because of other assets, your estate is subject to tax, the life insurance money can be used to pay the tax. Having cash available can prevent the beneficiaries from having to sell assets, such as a business or a home.

A Life Insurance Trusts can provide tremendous estate tax savings.  Not only will all of the life insurance money be available for the support of your children, but you can plan when and how your children are to receive the benefits.  Once a life insurance trust is set up, the rules can be easy to follow with  proper guidance and the benefits can last a lifetime.

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