Should You Put Your Life Insurance Policies Into a Trust? Examining the Pros and Cons

As you would imagine, most of our clients don’t make decisions involving their money on a whim. That’s why it’s common for us to be asked to outline the advantages and disadvantages of a strategy before implementing it. Here’s how that conversation usually goes when it comes to putting life insurance policies into a trust.

Calculating Your Total Estate

Before diving into any specific pros and cons, we’ll first propose a broader question that will help determine whether or not to put your life insurance policies into a trust: What will the total value of your estate be when you die? You may or may not be able to accurately calculate that figure at this point in your life, and that is fine.

The way it currently works, if you don’t expect that you will die with assets that exceed the current exemption amount of $11.2 million ($22.4 million per couple), then your life insurance can be owned individually or in a revocable living trust. It doesn’t make a difference because the death benefit will be income tax free when paid out and not subject to estate taxation either.

Here’s the problem that you may encounter: Tax laws can change. If, for example, the exemption amount were to drop back down to $1 million, imagine how many people would then become exposed to estate taxes. As a result, many people choose to do proper planning now to avoid complications down the road. So what should you do?

What to Consider When Establishing a Life Insurance Trust

If you expect your estate value will be over the exemption amount, or if the calculation is still unpredictable and you wish to cover your bases, you should establish an irrevocable life insurance trust (ILIT) and have the trust own your life insurance policies. What this does is remove the insurance proceeds from your estate completely so that they can remain income and estate tax free.

You should keep in mind that there are some potential disadvantages to owning assets inside of an irrevocable trust. The most important one is the loss of control that takes place once the assets are moved inside of the trust. While there is a trustee named to carry out the instructions of the trust, the grantor is effectively relinquishing ownership of the life insurance policy.

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In cases in which the life insurance policy isn’t established inside of the trust and is transferred into it (perhaps because your net worth is rising and you feel you may be above the exemption amount), it’s important to remember that there is a three-year look-back period. If you die within those three years, the insurance proceeds will be considered part of your estate and subject to estate taxation. This is why it usually pays to do this planning in your 60s or 70s rather than waiting until you are older.

The other move you could make is to establish the policy with yourself as the insured and your kids as owners and beneficiaries. You could then gift the premiums into the policy. For example, the annual gift tax exclusion is currently $15,000 per person. That means a married couple can gift $30,000 each year to a single person.

If a 60-year-old couple were to use this strategy, they may be able to purchase a $2 million policy for the benefit of their kids. The downside to this strategy is that there is literally no enforceable structure at all. Your kids are relying on you to gift the premiums, and if you don’t, the policy could lapse. They may also choose to cash the policy in 10 or 15 years after its established and there is nothing that you, as the insured, can do about it.  

At Howard Kaye, our goal is to help you pass as much money down to your heirs as possible. The trust structure is very important when it comes to setting up a proper life insurance strategy. It must be done correctly and according to the specific details of your financial life. Our advisors have decades of experience with this type of planning. Speak to us today by calling 800-DIE-RICH, and we’ll show you how to title your policies properly to keep them tax efficient.  

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