Avoiding Estate Taxation on Life Insurance Proceeds
To ensure that there is no estate taxation, a life insurance trust must also be the beneficiary of the life insurance policy.
Beneficiaries Inherit Even Though Not Named in the Life Insurance Policy
Upon your death, the trust will receive the death benefit proceeds from the life insurance policy. The trust can transfer these funds to your children, family members, or other beneficiaries as if you had left the money to them directly. However, these funds will not be part of your estate. Your beneficiaries will also not have to pay estate taxes on the funds they receive.
Transferring Insurance Policies Creates Problems
If you have an existing life insurance policy you can transfer the policy into an irrevocable life insurance trust for the purpose of avoiding estate taxes on the proceeds. However, be advised there is a three year look back period. In the event you die within three years of the date of the transfer of the trust, the Internal Revenue Service (IRS) will not acknowledge the existence of the trust and they will consider the proceeds of the trust as part of your estate for estate tax purposes.
Life Insurance Trusts and Gift Taxes
Irrevocable life insurance trusts do not avoid gift taxes. This is because they do not directly skip a generation. However the trust can be drafted using what is called a Crummy Power. This would allow the shelter of the trust from present gift taxes. The Crummy Power gives authority to the grandchildren to withdraw any amount from the corpus of the trust at the same date annually. For this provision to remain valid, a child must withdraw a small amount from the trust each year. Parents can authorize their children to withdraw $1 each year from the trust to meet this requirement and avoid gift taxes.
Estate Attorney
Irrevocable life insurance trusts are complicated estate planning devices. The estate planning issues related to each family are unique. It is strongly suggested you meet with an experienced estate planning attorney to deal with your specific estate planning needs.
