Understanding Life Insurance Trusts: How to Reduce or Eliminate Your Estate Tax Cost

This blog series will go through questions that are often asked by our clients when discussing life insurance trusts and estate taxes.

1. What does a life insurance trust do?

An irrevocable life insurance trust lets you reduce or even eliminate estate taxes, so more of your estate can go to your loved ones. It also gives you more control over your insurance policies and the money that is paid from them.

2. What are estate taxes?

Estate taxes are different from, and in addition to, probate expenses and final income taxes (which must be paid on any income you receive in the year you die). Some states also have their own death/inheritance taxes.
Federal estate taxes are expensive – the rate is 46% in 2006, 45% in 2007 and 2008 – and they must be paid in cash, usually within nine months after you die. Since few estates have this kind of cash, assets often have to be liquidated. But estate taxes can be substantially reduced or even eliminated – if you plan ahead.

3. Who has to pay estate taxes?

Your estate will have to pay estate taxes if its net value when you die is more than the “exempt” amount set by Congress at that time. Here is the current schedule:

Year of Death………..Estate Tax “Exemption”

2006, 2007 & 2008………..$2 million

2009………..$3.5 million

2010………..N/A (repealed)

2011 and thereafter………..$1 million

4. What makes up my net estate?

To determine your current net estate, add your assets then subtract your debts. Many people are surprised that insurance policies in which they have any “incidents of ownership” are included in their taxable estates. This includes policies you can borrow against, assign or cancel, or for which you can revoke an assignment, or can name or change the beneficiary.
You can see how life insurance can increase the size of your estate–and the amount of estate taxes that must be paid.

5. How does an insurance trust reduce estate taxes?

The insurance trust owns your insurance policies for you. Since you don’t personally own the insurance or have any “incidents of ownership,” it will not be included in your estate — so your estate taxes are reduced.

Let’s say you are married, with a combined net estate of $5 million, $1 million of which is life insurance. With a tax planning provision in a revocable living trust or will, you can protect up to $4 million in 2006-2008 from estate taxes. But if you die in 2006, your estate would have to pay $460,000 in estate taxes on the additional $1 million ($450,000 in 2007 and 2008). With an insurance trust, the $1 million in insurance would not be in your estate. That would save your family at least $450,000 in estate taxes.

For additional questions on life insurance trusts and estate taxes, please contact our Estate Planning Attorney in Woodland Hills, Ca today.

Published in: on July 25, 2011 at 5:04 pm  Comments (2)  
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Tax-Free Gifts and the Irrevocable Life Insurance Trust (ILIT) : Reducing the Estate Tax

Tax-Free Gifts

This is easy and it doesn’t cost anything. Each year, you can give up to $12,000 ($24,000 if married) to as many people as you wish. So if you give $12,000 to each of your two children and five grandchildren, you will reduce your estate by $84,000 (7 x $12,000) a year – $168,000 if your spouse joins you. (This amount is now tied to inflation and may increase every few years.)

If you give more than this, the excess will be considered a taxable gift and will be applied to your $1 million gift tax exemption. Charitable gifts are unlimited. So are gifts for tuition and medical expenses if you give directly to the institution.

Irrevocable Life Insurance Trust (ILIT)

An easy way to remove life insurance from your estate is to make an ILIT the owner of the policies. As long as you live three years after the transfer of an existing policy, the death benefits will not be included in your estate.

Usually the ILIT is also beneficiary of the policy, giving you the option of keeping the proceeds in the trust for years, with periodic distributions to your spouse, children and grandchildren. Proceeds kept in the trust are protected from irresponsible spending and creditors, even ex-spouses.

For more information on-free gifts, irrevocable life insurance trusts and reducing your estate tax, please contact our experienced Estate Planning Attorney in Woodland Hills.

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Published in: on May 19, 2011 at 10:05 pm  Comments (1)  
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