Tag Archives: Trust Fundamentals

How Are Life Insurance Trusts Used?

There are several common reasons life insurance trusts are used in an estate plan. Life insurance is an extremely valuable financial planning tool, that when combined with the flexibility and protections of a trust, provides some great benefits.

Provide Liquidity for Estate Administration
A common use for life insurance trusts is to provide an easily accessible source of liquidity for the insured’s estate upon their passing. As is often the case, many assets in an estate are illiquid, such as a house. Also, there is often an immediate need for liquidity after a person’s death. The estate may be required to pay taxes and will incur other administrative and legal costs. Therefore, many financial planners recommend a life insurance trust to provide liquidity for their client’s estate plans. When the insured passes, the life insurance proceeds are paid into the trust that is the policy’s beneficiary. These proceeds can then be used to purchase illiquid assets from the estate, thus providing protection for those assets and cash for the estate’s needs. A real-world example where this strategy might be used is to protect a surviving beneficiary, perhaps the spouse or a child of the insured, from being forced to sell a home on short notice to raise cash.

Minimize Federal Estate Tax Liability
Although life insurance proceeds are usually exempt from income taxes, proceeds are not exempt from estate taxes when the insured personally owns or controls the policy. Compared to personally owning an insurance policy, a key benefit of an ILIT is that the trust is the beneficiary of the policy, and the assets owned by the trust are not considered part of the insured’s taxable estate. For insurance proceeds to pass outside of the insured’s estate, the trust must own and be the beneficiary of the insurance policy.

Maximize Generation-Skipping Transfer Tax (GST) Planning Opportunity
An insurance trust can be used to maximize a grantor’s GST tax exemption by using annual gifts to the trust to fund the insurance premiums. Since insurance proceeds in a properly structured insurance trust are excluded from the grantor’s estate, multiple generations of the family may benefit from the trust’s assets free of GST tax.

Avoid Gift Tax
A life insurance trust can be structured in a way that allows the grantor to maximize their annual gift tax exclusion each year with contributions to the trust. Annual gifting enables the trustee to pay the annual insurance premiums while removing a significant amount of assets from a grantor’s estate over time.

Maintain Government Benefits
If a beneficiary is currently receiving government aid, such a Social Security disability income or Medicaid, a life insurance trust can be used to ensure that life insurance proceeds and ongoing distributions from the trust will not interfere with the beneficiary’s eligibility for government benefits.

Stipulate the Distribution of Funds
With a life insurance trust, the grantor can stipulate in the terms of the trust how the insurance proceeds are to be distributed. The trust can provide the trustee with discretionary powers to make distributions to beneficiaries. This could be useful in incentivizing certain achievements, such as graduating from college, or to protect the assets for the intended beneficiaries in blended family situations.

Protect against Creditors
A properly drafted insurance trust can provide asset protection for the life insurance policies held in trust. An irrevocable trust can provide asset protection from creditors of both the grantor and the beneficiaries. Once distributions are made from the trust to a beneficiary, a creditor of the beneficiary can attach any distribution, but as long as assets are held in trust, they can retain creditor protection. Asset protection laws vary from state to state, and several states, including Alaska, Nevada, and Delaware, offer excellent protections for trusts.

When is a Non-Grantor Trust Preferable?

Grantor trusts became one of the most commonly used tools for estate tax planning beginning with the enactment of the Tax Reform Act of 1986 (P.L. 99–514), which substantially reduced the increases in federal income tax rates. Two major perceived benefits have been (1) to allow the trust to grow free of income taxes because the income of the trust is attributed to the grantor1 and (2) the ability of the trust’s grantor to sell appreciated assets to the trust without a gain or other income recognition in exchange for a note. This note typically has interest at the applicable federal rate, and this interest is not taxed as income. Instead, the position of the Treasury and the Internal Revenue Service (IRS) is that the grantor will continue to be treated as the owner of the trust assets for federal income tax purposes.2

Grantor trusts also offer other benefits. For instance, the grantor, or the grantor’s spouse under Section 1041, can buy low basis assets from a grantor trust before death and achieve an automatic (commonly called a “tax-free”) change in basis upon death. Moreover, a grantor trust whose grantor is a U.S. individual taxpayer is automatically a qualified S corporation shareholder.3

 

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Grantor Trusts and Income Tax Reporting Requirements: A Primer

A trust is a “grantor trust” for income purposes to the extent that under the rules articulated in subpart E (section 671 through 679) of part 1 of subchapter J and chapter 1 of the Internal Revenue Code of 1986, as amended, the trust’s income, deductions, and credits against tax are attributed to its grantor or its beneficiary. A trust may be a grantor trust in its entirety or only in part, and may be a grantor trust with respect to one or more taxpayers.

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Tangible Personal Property

Every estate includes tangible personal property: cash, clothes, jewelry, furnishings, vehicles, pets, artwork, gold, alcohol, boats, electronics, cars, wine, guns, etc. Challenges you may face are as varied as the assets involved. This practical webinar will discuss critical planning, drafting, and tax considerations of planning for tangibles.

Determining How and When to Gift Illiquid Assets

○ Most gifts to charities are in the form of cash or marketable securities.

○ Gifts of illiquid assets are a creative way to make large contributions with amazing benefits for the charity and donor.

○ Gifting illiquid assets can be an effective way to fulfill a charitable goal.

○ May allow the donor to use an asset that perhaps was once illiquid, was a non-producing asset or perhaps is expensive to maintain.

○ They are considered a complex asset and will take careful planning to execute.

○Some examples of illiquid assets:

         ■ Real Estate

         ■ Artwork or other Collectibles

         ■ Private Company Stock

         ■ Private Entities (LLC, LP)

         ■ Life Insurance

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Irrevocable Life Insurance Trust (ILIT) Fundamentals & Benefits: Janet Tempel, Sr. Trust Officer

In this podcast Amber Gunn, Trust Officer for Peak Trust Company, talks with Janet Temple, a Senior Trust Officer at Peak Trust, on Irrevocable Life Insurance Trust (ILIT) Fundamentals and Benefits. Below are highlights from the podcast.

 

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What is an ILIT?
This acronym stands for irrevocable life insurance trust, designed to be the owner and the beneficiary of one or more life insurance policies. This generally refers to an irrevocable trust that holds life insurance policies. Peak Trust Company supports a large number of irrevocable trusts that hold both life insurance and other assets.

 

What are the benefits of an ILIT?

    • Provide liquidity for estate administration – The life insurance proceeds from an ILIT can provide cash to pay taxes, administrative costs, and other expenses of settling an estate, without forcing the sale of illiquid assets.
    • Minimize estate taxes – Life insurance proceeds from a properly structured ILIT are excluded from the insured’s taxable estate, avoiding estate taxes.
    • Generation-skipping transfer (GST) tax planning – An ILIT allows maximizing use of the GST tax exemption to pass assets to grandchildren free of GST taxes.
    • Avoid gift taxes – An ILIT takes advantage of annual gift tax exclusions to remove assets from the grantor’s estate over time by funding insurance premiums.
    • Maintain government benefits – An ILIT ensures that insurance payouts do not interfere with means-tested government benefits for beneficiaries.
    • Control distributions – The grantor can provide guidelines in the ILIT controlling when and how proceeds are distributed to beneficiaries after the grantor’s death.
    • Insurance premium tax savings – Certain states like Alaska and Delaware have favorable premium tax rates for ILITs.
    • Asset protection – Assets held in a properly drafted ILIT receive creditor protection from the grantor’s and beneficiaries’ creditors.

     

    How Do ILITs work once set up?

    • An ILIT is an irrevocable trust created to own and control a life insurance policy. The trust, not the insured, is named as beneficiary of the policy.
    • The ILIT is funded through annual gifts made by the insured (the grantor) to cover policy premiums. This allows use of the gift tax exclusion.
    • The trustee files tax returns, administers trust assets, issues notices to qualify gifts, and distributes proceeds. A professional trustee is often used.
    • At the insured’s death, policy proceeds are paid to the ILIT and can be used tax-free to provide liquidity for the estate or pass to heirs.
    • Proceeds held in an ILIT avoid estate taxes and creditors because they are not legally owned by the insured at death.
    • An ILIT allows control over distribution of proceeds to heirs based on guidelines in the trust set up by the insured.

    In essence, an ILIT is a specialized trust that owns life insurance, removing it from the insured’s taxable estate, to maximize tax advantages and control distributions.
     

    What are the trustee duties associated with an Irrevocable Life Insurance Trust?
    The trustee will have the same duties they would for an irrevocable trust with the exception of a few additional duties specific to insurance companies.
     

    How should the attorney and the insurance advisor work together to set expectations with the clients about the administration of an ILIT?
    Grantors should have a full understanding of the procedures involved in making gifts to the trusts, how criminal notices work, and withdrawal rights. They should also communicate fully with the beneficiaries to explain the purpose of the trust and why it was set up as well as their rights. Grantors should also plan ahead to ensure all costs are covered in various situations.
     

    How do tax returns work with an ILIT?
    Most ILITs have EINs rather than utilize the grantor’s social security number. Any income coming into the trust will need a grantor return filed. However, income earned with a policy is
    tax-free income.
     

    What are the benefits of using a top-tier jurisdiction like Alaska or Nevada for an ILIT?
    One of the benefits of an irrevocable life insurance trust is that it provides credit protection. Alaska and Nevada are both top-tier jurisdictions for credit protection. ILITs that hold large policies are frequently designed as dynasty trusts, which Alaska and Nevada are also good jurisdictions for. A benefit to Alaska is the ability to waive certain duties of the trustee to keep fees, costs, and premiums down.

    If you have further questions about Irrevocable Life Insurance Trusts after listening to the podcast or want to learn more about Peak Trust Company, contact us today.