INSURANCE TRUST FREQUENTLY ASKED QUESTIONS
is a life insurance trust?
Death benefits paid on a life insurance policy pass to the
beneficiaries of the policy free of income taxes. But life insurance
proceeds may be subject to federal estate taxes instead. You can make
sure that your life insurance pays your beneficiaries free of both
federal estate taxes and income taxes by having your insurance owned
by an irrevocable life insurance trust. According to "Wealth
Enhancement & Preservation" (The Institute Inc., Denver),
"Because your irrevocable life insurance trust will be considered
the owner of the life insurance upon your death, the value of your
life insurance will be excluded from your gross estate. There is one
exception to this estate tax-free rule, however. If you transfer the
ownership of an existing policy on your life to your irrevocable life
insurance trust and you die within three years of the transfer, the
entire value of the policy is brought back into your estate for
federal estate tax purposes." To guard against such a trap, some
financial experts say that you should have the trustee of your
irrevocable life insurance trust purchase a new policy on your life so
that if you die within three years, the policy is excluded from your
What is an irrevocable trust
and what are its tax advantages?
When you create a trust, you decide whether the trust will be
revocable or irrevocable. A revocable trust can be changed or even
dissolved by you at any time. An irrevocable trust, however, can never
be changed. The assets you put into it must stay there. Beneficiaries
cannot be added or deleted. And the only way to change the trustee is
for that person to die or agree to resign. Why, then, choose to make
your trust irrevocable? For tax advantages. An irrevocable trust or
the beneficiary of the trust pays the income taxes on what its assets
earn. When you die, the trust property is not part of your estate and
will not be subject to death taxes. Conversely, revocable trusts offer
no tax benefits at all. If you want lots of flexibility, make your
trust revocable. But if you want tax breaks, you must forgo
flexibility and form an irrevocable trust instead. -- Kenneth J.
Whatís the purpose of
establishing an irrevocable life insurance trust?
The aim of an irrevocable ife insurance trust is to keep the death
benefits from a life insurance policy outside of the policyholderís
estate -- and thereby remove the chance that the proceeds will be
subject to a federal estate tax that can reach as high as 55%.
According to "Wealth Enhancement & Preservation" (The
Institute Inc., Denver, Colo.), "A properly established
irrevocable life insurance trust owns life insurance on the life of
the trust maker, thereby keeping the life insurance proceeds outside
of his or her estate and avoiding federal estate tax (federal income
tax is also avoided for different reasons). An irrevocable life
insurance trust keeps policy proceeds free of federal estate tax upon
the death of the trust maker and also on the subsequent death of his
or her spouse. "The proper use of this type of trust allows the
trustees to satisfy the trust makerís estate settlement costs and
death tax obligations without subjecting the insurance proceeds to
those costs and taxes. By utilizing this planning vehicle, a 50%
federal estate tax bracket taxpayer can purchase half as much life
insurance as he or she would own personally and still get the same
after-tax insurance benefit for his or her beneficiaries. Or he or she
could double the amount of the coverage passing to his or her
beneficiaries without paying a dime more of premium."
What is the downside of
establishing an irrevocable life insurance trust?
While establishing an irrevocable life insurance trust can provide you
with several benefits, the trusts have their disadvantages. Some
people consider these trusts too complicated and expensive to
establish and maintain. They donít care much about controlling the
proceeds from their life insurance policy, even if it means allowing
the Internal Revenue Service to keep up to 55% of the money. According
to "Wealth Enhancement & Preservation" (The Institute
Inc., Denver), "Other individuals are concerned about the loss of
control over the terms of the irrevocable life insurance trustís
provisions and the inability to use the cash value of the life
insurance. These people want to ensure that if tax laws change or
their circumstances change, they can exercise some kind of control
over the trust and its terms. Although the cost to create and maintain
these trusts is but a small fraction of the eventual tax savings that
will pass to their children and grandchildren, some people do not feel
comfortable using this technique."
How does an irrevocable life
insurance trust pay the insurance premium?
Typically, the premiums for life insurance held by an irrevocable life
insurance trust are paid from annual gifts made to the trust by the
person who establishes it. Crummey demand powers are used to preserve
the tax-free gift exclusion for gifts of a present interest up to
$10,000 per beneficiary.
Who should I pick as the
trustee of my irrevocable life insurance trust?
When youíre deciding whom to name as the trustee of your irrevocable
life insurance trust, you should automatically scratch both your name
and the name of your spouse from the list. According to "Wealth
Enhancement and Preservation" (The Institute Inc., Denver,
Colo.), "It is very clear under tax law that you should not be
the trustee of an irrevocable life insurance trust that you set up.
The trustee probably should not be your spouse either. Many planners
suggest that a good trustee for an irrevocable life insurance trust
might be the local bank trust department. Bank trust departments deal
with irrevocable trusts on a regular basis, as do accountants. Because
of the technical nature involved in the administration of an
irrevocable life insurance trust, it may not be a good idea to use
individuals as your trustees unless they are extremely well versed and
competent to handle the technicalities involved."
What is a Crummey trust?
A Crummey trust is a type of irrevocable life insurance trust that
allows the trustís beneficiaries to demand that the trustee pay them
their share of the monies contributed to the trust within a specified
period. The name comes from D. Clifford Crummey, whose court case
resulted in the approval of the demand right technique. Those rights,
called Crummey rights or Crummey power, have since been expanded to
beneficiaries of many other types of trusts as well. Premiums must be
paid on the life insurnace in the trust. Typically the grantor makes
gifts to the trust of up to $10,000 per beneficiary. However, these
gifts must be gifts of a present interest or the $10,000 gift
exclusion will not apply. The Crummey power solves this problem.
What is Crummey demand power
and how does it affect gift taxes?
Crummey demand power is an important tool in planning gift taxes. This
power permits all transfers to a trust to qualify for the $10,000 gift
tax exclusion even if the trust benefits are delayed into the future.
The term "Crummey" comes from E. Clifford Crummey, whose
court case resulted in the approval of the demand right technique.
How are the death proceeds paid
to an irrevocable life insurance trust used by an estate to pay death
When the death benefits from an insurance policy are paid to an
irrevocable life insurance trust, the estate itself can access the
money to pay death taxes in one of two ways. According to "Wealth
Enhancement & Preservation" (The Institute Inc., Denver), the
trustees of the trust can lend the proceeds to the estate and take
back a promissory note. In a better alternative, the trustees can buy
assets from the estate and own those non-liquid assets in the
irrevocable life insurance trust.
How do I transfer my group life
insurance policy to an irrevocable life insurance trust in order to
avoid estate taxes?
Many workers have a group life insurance policy through their
employer. By placing these policies in an irrevocable life insurance
trust, you can keep the proceeds out of your estate when you die and
thus guarantee that the benefits will be free from the federal estate
tax than can top 50%. According to "Wealth Enhancement &
Preservation" (The Institute Inc., Denver, Colo.), "The
transfer is made by preparing an assignment which irrevocably assigns
all your rights under the group policy to your irrevocable trust. This
would include your rights to ownership, your rights to change the
beneficiaries, and your rights to convert the policy to a permanent
form of insurance. This change of ownership should be documented and
forwarded to the insurance company for its acknowledgment. The
insurance company may have a form that is appropriate for your use.
"However, it may be necessary to use your attorney. If any
identification documentation is required (i.e. ownership certificates,
etc.), this documentation should be reissued by the insurance company
in the name of the irrevocable trust. "Some group policies
include provisions prohibiting assignment of employeesí rights. If
you find yourself in this situation, you should contact the insurance
company and ask that it waive this prohibition; this usually requires
the written consent of the insurance company and your employer."
Is there a way to have access
to the cash value of life insurance owned in an irrevocable life
The cash value of a life insurance policy held within an irrevocable
life insurance trust generally canít be touched. But using a special
"split-dollar" arrangement can make the cash accessible.
According to "Wealth Enhancement & Preservation" (The
Institute Inc., Denver, Colo.), "A significant problem with
purchasing life insurance in an irrevocable trust is that the cash
value of the life insurance owned by the trust will be outside the
reach of the trust maker during his or her lifetime. "A family
split-dollar arrangement structures the ownership of the life
insurance policy so that the insurance coverage is owned and held by
the irrevocable life insurance trust, and the cash value or investment
component of the policy is held separately by the trust makerís
spouse without causing the insurance death benefit to be included in
the makerís estate for federal estate tax planning purposes."