Discover How an Irrevocable Life Insurance Trust Can Help with Your Estate Planning

Definition of trustDid you know that if you own a life insurance policy in your own name, its proceeds will be included in your estate, and there’s a possibility it will be taxed up to 40%?
However, if you use an irrevocable life insurance trust, or ILIT, to hold title to your life insurance policy, you may avoid having the death benefit included as an asset in your estate. This can save your heirs hundreds of thousands (maybe even millions!) of dollars in taxes.
It’s a complicated process, but creating an ILIT might be worth it.
Motley Fool’s recent article, “What's an Irrevocable Life Insurance Trust and Why Do I Need One?” explains just what an irrevocable life insurance trust looks like.
An ILIT is a trust with the primary purpose of holding a life insurance policy and the cash needed to pay premiums on that policy. You would need to fund the trust with money to pay initial premiums when you set it up. The trust then buys the life insurance policy, naming you as the insured.
The ILIT has to be created so that it avoids giving you “incidents of ownership.” These are the rights to borrow against the policy, to change beneficiaries or to change how proceeds are distributed from the trust. If you retain any of these rights, then the death benefit will be included in your estate and subject to estate taxes.
The ILIT usually pays the ongoing premiums by receiving future gifts from you as the person who set up the trust. After your death, the other provisions of the trust will apply.
A named trustee will manage the assets and make sure the assets are invested to meet the future needs of your beneficiaries. When all the protective terms of the ILIT are satisfied, the trust can terminate, and final distributions are made to its recipients.
The major benefit of the ILIT is that the proceeds of the life insurance policy aren’t taxed. The estate tax on a $1 million policy can be as much as $400,000—so the savings from an irrevocable life insurance trusts may justify the expense of an attorney creating it for you.
There can be some issues with ILITs—the most common of which is when the cost of continuing the life insurance policy becomes prohibitively high. That can make the ongoing funding of the trust burdensome. The ILIT trustee might have to borrow against the policy value or surrender the policy entirely. It can mean that the beneficiaries are at odds with the trustee.
Despite this, potentially saving a large amount of money in estate taxes makes ILITs worth the effort. Work with an experienced estate planning attorney so your ILIT meets your needs and those of your family.
Reference: Motley Fool (August 24, 2016) “What's an Irrevocable Life Insurance Trust and Why Do I Need One?”


The Ins and Outs of Community Property

Couple with house planMany married couples living in the U.S. own assets that are deemed legally separate. This may include a business or real property purchased in one person’s name alone. The reason for this designation is that the laws of most states treat married individuals as financially unrelated to their spouse, except for joint accounts and those assets specifically mentioned in a will. However, there are some states called community property states that have different laws on this issue.
As a result, it’s important to know about community property laws in the event you move to one of these jurisdictions or already live in one.
Barron’s article, “How Community Property States Are Different,” explains that Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are the states in which everything you acquire during a marriage is considered legally owned by both spouses. For example, their state statutes view a couple as the co-owners of a business with a 50-50 partnership.
Here are a few other issues to consider.
Premarital assets. Typically, any wealth acquired before the marriage and any inheritances acquired at any time by one spouse are not the property of the other spouse. If you intend to keep them separate, leave them out of your community accounts created after the marriage. If you want to join finances, an estate planning attorney can help you with pre- and post-marital agreements and community property agreements to pool assets.
Estate plans. In most states, a married couple’s assets are divided evenly in life, and the same is true when one dies. One half the couple’s assets become part of the estate, which can make for major taxes in some situations. If a couple buys a home for $1 million, which then appreciates to $5 million, half of the value of the home—or $2.5 million—becomes a part of the decedent spouse’s estate. It’s given a step-up in basis—a readjustment of the value of the home to the market price over what was initially paid. But the surviving spouse keeps the original cost basis of $500,000. If that spouse wanted to sell the property upon the death of the spouse, he or she would have a cost basis of $3 million (the $500,000 cost basis plus the adjusted basis of $2.5 million) amounting to a $2 million capital gain.
Community property states are a plus in this case because they give a step-up in basis to the entire home. In this example, the surviving spouse will also get a step-up in basis, which means if he or she sells the home there would be no capital gains tax owed. However, the step-up in basis can complicate wealth transfer planning.
Gifting. In community property states, both spouses have to agree on gifts from joint funds. No one can make a gift of your property without your consent, and without that consent, the spouse who didn’t make the gift can revoke the gift at a later date. It’s best to make sure it’s in writing—even when it’s a gift to each other.
Life insurance. Talk with an experienced estate planning attorney before you create an irrevocable life insurance trust. For example, a husband creates an irrevocable life insurance trust to benefit his wife, and the trust buys a $10 million life insurance policy on his life. He will need to be certain that any gifts made to the trust and used to pay the premiums are paid for from a non-community property account—payments cannot come from a joint account. Otherwise, it places a portion of the trust into the estate of his wife, which defeats the purpose of having an irrevocable life insurance trust in the first place and subjects it to an estate tax. Sign a transmutation agreement, which makes the gifts to the trusts entirely one person’s.
It’s important to remember that when community property laws are advantageous to your situation, you can carry community property over with you when you move to a new state. An agreement can preserve the community property state of already-acquired assets and conserve joint trusts to save them from getting comingled with assets in the new state.
Be sure to consult with a qualified estate planning attorney who understands community property law.
Reference: Barron’s (June 28, 2016) “How Community Property States Are Different”

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