A life insurance trust owning your policy, coupled with proper payment transfers, will keep the value of the life insurance out of your estate. Life insurance is typically part of an estate’s gross value. The estate is then allowed certain deductions to reach a net estate. If that estate is then below the State estate tax threshold (WA = $2M flat) or Federal ($5.4 indexed), there are no estate taxes owed. Transfers to US spouses or charities are 100% deductible to the estate so such life insurance does not create estate tax issues. Life insurance alone, to non US spouse or charity beneficiaries, can create a taxable estate. I have several clients with multi-million dollar policies. Are there ways to keep life insurance out of an estate? Yes!
Life Insurance Terms to Know
The owner of a life insurance policy is the one who has the rights that are stipulated in the contract. These include the right to name a beneficiary; the right to participating dividends; the right to surrender the policy for its cash value; and the right to transfer ownership.
The insured, who is often the owner of the policy, is the person whose death causes the insurer to pay the death claim to the beneficiary. The beneficiary can be a person, trust, estate, or business.
Although the owner has the right to name the beneficiary, whether the owner can change the beneficiary depends on whether it is a revocable beneficiary or irrevocable beneficiary.
Transfer Policy Ownership
For those estates that will owe taxes, whether life insurance proceeds are included as part of the taxable estate depends on the ownership of the policy at the time of the insured’s death. If you want your life insurance proceeds to avoid federal taxation, you’ll need to transfer ownership of your policy to another person or entity. Here are a few guidelines to remember when considering an ownership transfer:
- Choose the new owner (it may be the policy beneficiary).
- Call your insurance company for the proper assignment, or transfer of ownership, forms.
- The new owners must pay the premiums on the policy. However, you can make bonafide gifts to the new owner to help pay the premiums.
- You will give up all rights to make changes to this policy in the future.
- Ownership transfer is an irrevocable event. People who gifted policies to spouses usually regret it in a divorce.
- Obtain a written confirmation from your insurance company as proof of the ownership change.
Life Insurance Trust
A second way to remove life insurance proceeds from your taxable estate is to create an irrevocable life insurance trust (ILIT). In order to complete an ownership transfer, you cannot be the trustee of the trust and you may not retain any rights to revoke the trust. In this case, the policy is held in trust and you will no longer be considered the owner. Why choose trust ownership rather than transferring ownership to another person? One reason might be that you still wish to maintain some legal control over the policy. Or perhaps you are afraid that an individual owner may fail to pay premiums, whereas in the trust you can ensure that all premiums are paid in a timely manner. If the beneficiaries of the proceeds are minor children from a previous marriage, an ILIT will allow you to name a trusted family member as trustee to handle the money for the children under the terms of the trust document.
If you want to discuss either of these ideas, give me a call or book a no cost initial consult.