It’s never too soon to start estate planning, especially if you have a young family dependent on your income. An irrevocable life insurance trust is a planning tool that provides a death benefit as well as a way to reduce estate taxes. By creating one at a relatively young age, you benefit from low insurance premiums that will only rise if you wait.
Estates and Taxes
Any assets you place in an irrevocable trust now belong to that trust, reducing the size of your taxable estate. In 2013, the federal estate tax applies only on an amount in excess of $5.25 million. The tax rate on the largest estates is 40 percent. Your spouse doesn’t have to pay taxes on your estate, but the tax kicks in on the spouse’s death or if the beneficiary is another person. You can’t terminate or change an irrevocable trust, so you must exercise care when setting one up -- an estate-planning attorney or financial adviser can be helpful.
Irrevocable Life Insurance Trust
Normally, life insurance proceeds are free from income tax but not estate tax. An irrevocable life insurance trust owns one or more life insurance policies on the life of the grantor -- the person setting up the trust. The trust is the beneficiary of the policies, which means your heirs don’t have to shell out the estate taxes on the insurance proceeds. You fork over the insurance premiums by making gifts to the trust, thereby reducing your taxable estate. You can give up to $13,000 a year without triggering gift taxes.
Term life insurance is a poor choice for an irrevocable life insurance trust because you may outlive the policy. If you plan to use renewable term insurance, the premiums will increase with each renewal, and insurance companies generally don’t issue new term policies for persons older than 80. In contrast, you can’t outlive a permanent policy, such as whole or universal life, as long as you pay the premiums. By starting early, you can enjoy relatively low premiums that remain stable as you age.
If you contribute an existing insurance policy to an irrevocable life insurance trust, you must survive for another three years to exclude the insurance proceeds from your estate. However, you can avoid this problem by having the trust purchase a new policy, which then has no such waiting period. A whole life policy builds up cash value and is more expensive than a universal policy. If you are mainly concerned with the death benefit, you can save money with a universal policy. Your trust cannot pay your estate taxes directly, but your heirs may be able to borrow from the trust or sell assets to the trust to help pay your estate taxes.
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