The Benefits of Creating an Irrevocable Life Insurance Trust

Taking out a life insurance policy is one of the best estate planning tools available, especially if you are a parent with young children. One of the best ways to protect your life insurance policy is to create an irrevocable life insurance trust. These specialized trusts allow you to transfer ownership of your life insurance policy into trust. If a life insurance policy is part of your estate plan, it is worth looking into the benefits of creating an irrevocable life insurance trust.

An irrevocable life insurance trust will manage and distribute the life insurance policy proceeds upon your death. An irrevocable life insurance trust can own individual and second-to-die life insurance policies. In a second-to-die life insurance policy, the insurance company insures two lives and will pay out benefits when the second person passes away. Second-to-die life insurance policies are popular with married couples. It is different from a traditional life insurance policy because the surviving spouse does not get the benefits. Rather, the benefits are passed onto the named beneficiaries once the second spouse passes away.

Regardless of which type of life insurance policy you put into an irrevocable life insurance trust, the trust still has several parties involved in its creation and management. The grantor is the person who creates the trust, the trustees manage the trust, and the beneficiaries receive the assets of the trust. We will discuss the benefits of creating an irrevocable life insurance trust below.

When you create a properly drafted irrevocable life insurance trust, the beneficiaries’ contributions are considered gifts by the Internal Revenue Service (IRS). To avoid gift taxes, you should notify beneficiaries of the trust regarding their right to withdraw a share of the contributions for a certain time period, usually 30 days, using a Crummey letter. After the time period, trustees will be able to use their contributions to pay the policy premium for life insurance.

Creating an irrevocable trust like this qualifies the transfer for an annual gift-tax exclusion. This process makes the gift a present rather than a future interest, avoiding the need to file a gift tax return in many cases. It is important to discuss this process with your lawyer, who will guide the tax consequences involved with creating the trust. Currently, an individual can give $15,000 per year to as many people as they choose. The limit is $30,000 for married couples.

Currently, the generation-skipping transfer tax imposes a 40% tax on transfers and outright gifts in trust to the benefit of people who were over 37.5 years younger than the donor. A common example of a generation-skipping transfer tax would be someone giving a gift to their grandchildren instead of their children. When you create an irrevocable life insurance trust, you can leverage the generation-skipping transfer tax exemption by using gifts you make into the trust to buy and pay for the life insurance policy, so long as a number of requirements are met. The proceeds from your life insurance policy will not be included in your estate and will avoid the generation-skipping transfer tax. Thus, you can use an irrevocable life insurance trust to provide assets for your children, grandchildren, and even great-grandchildren. They can benefit from the assets of the trust, free of the estate tax and generation-skipping transfer tax.

Another benefit of an irrevocable life insurance trust is the protection of your assets from creditors, including judgments from lawsuits. If you carefully craft an irrevocable trust, you can protect your assets from most creditors. However, North Carolina provides exceptions permitting certain types of creditors to go after funds in irrevocable trusts. It is important to speak with an estate planning attorney to determine what steps you need to take to protect your assets from creditor’s claims in an irrevocable trust.

An irrevocable life insurance trust can be an essential tool in your estate planning toolkit. People of various financial backgrounds can benefit from creating one of these specialized trusts that can help ensure that you make the best possible use of your policy to benefit your family. The estate planning attorneys at Arnold & Smith, PLLC, are here to help Charlotte, Mooresville, and Monroe area residents to utilize an irrevocable life insurance trust as part of their comprehensive estate plans. Contact us today to schedule your initial consultation to learn how we can help you.