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by Igor Krishtul

Life insurance is a unique product. It is different from other financial products. Not only that, it is different from other insurance contracts. Life insurance plays a vital role in many aspects of financial and estate planning.

Living trusts play an important role in your planning as well. Living trusts provide an efficient way to own, manage and distribute property – both during life and after death.

Together, life insurance and living trusts form a very powerful, efficient and flexible financial and estate planning tool. Any trust that owns or is a beneficiary of a life insurance contract may be referred to as a life insurance trust.

There are many “experts” claiming that a life insurance trust must be irrevocable. Unfortunately, they include both insurance and legal professionals. Let me share a little secret with you – this is not true. That’s right, your life insurance trust does not have to be irrevocable.

Many people (including advisors) believe that life insurance death benefits avoid probate. This may or may not be true. The death proceeds payable to a competent adult beneficiary normally do not require probate. Your life insurance beneficiary, however, can be a minor or mentally ill person. In this situation, the case will end up in a probate court.

Some people name their estate as beneficiary. Sometimes, this is done intentionally. More frequently, this is done in error. An estate may also become a beneficiary of death proceeds by default. Whatever the reason, when the death proceeds are payable to the estate, they do not escape probate.

Assets in a revocable trust are included in taxable estate. But, your estate may not be plentiful enough to worry about tax savings. Also, estate taxation may not be your primary concern. Keep in mind that saving taxes is only one of many elements of your estate plan.

Irrevocable life insurance trusts cause additional headaches. But, they offer benefits not available otherwise. If your estate is big enough, it makes sense to consider irrevocable trusts. Also, keep in mind that life insurance can substantially increase your estate at death.

The grantor loses control over property held in an irrevocable trust. In substance, he or she is no longer the true owner of the policy. This fact is recognized by the IRS. Accordingly, the death benefits are not subjected to estate taxation. This exclusion does not come automatically.

First, there must be no incidence of ownership in a life insurance policy by the grantor. If an insurance policy is transferred to an irrevocable trust within three years of death, the proceeds will be included in taxable estate. Don’t seem like much, right? Yes. But, there are other strings attached.

Money contributed to life insurance trusts is used to pay life insurance premiums. Accordingly, this money is not available to trust beneficiaries for withdrawal. In other words, they have no way to immediately enjoy the property (e.g. money) gifted to such trusts. This raises the issue of gift taxation. The IRS brought this up in Crummey vs. Commissioner case back in the 1960s. To make the story short, additional steps must be taken to get most benefits out of the irrevocable arrangement.

If you own life insurance contract or are in a process of applying for one, you should at least consider setting-up a life insurance trust. This can greatly benefit you and your loved ones. Such trusts can be created specifically for your life insurance. Your trust can also own insurance along with other assets.


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