Margaret S. faced the ultimate thief. She lost her husband to a sudden cardiac arrest. Only 59 and in seemingly good health, at least he had the foresight to keep a million-dollar life insurance policy on himself, naming her as beneficiary. Referred to us by a friend, Margaret arrived at our first appointment shaken and afraid. Not only was she grieving the loss of her life partner, she now faced a torrent of consequences from this sudden windfall of money.
The IRS demanded its sizable share of the proceeds to cover the tax liability. And creditors demanded the rest to pay off debts she didn’t even know her husband had. How would she provide for herself and her three children?
I wish I could tell you this situation is uncommon. In fact, it is all too common. More than half of all Americans do not have a will or an estate plan. An unbelievable 92% of adults under age 35 do not have a will or estate plan.
Sadly, it was too late to help Margaret. But it is not too late to help you.
Irrevocable Life Insurance Trust
I want to introduce you to a powerful device called the irrevocable life insurance trust, ILIT for short. Think of an ILIT as a holding device that owns your life insurance policy for you, thus removing it from your estate. Everything in your name at the time of your death the government includes in your estate for tax purposes.
As its name implies, once you set up an ILIT and place your life insurance policy or policies in it, you cannot take them back, at least in your own name. ILITs offer the flexibility you need to name beneficiaries and stipulate the terms by which they receive benefits, and you can choose the trustee you wish to manage this device. It is critical to design the ILIT correctly and to follow all guidelines. (For related reading, see: 7 Reasons to Own Life Insurance in an Irrevocable Trust.)
How ILITs Solve Estate Problems
ILITs wipe away the messy problems that can stain the estate planning effort. Consider these beneficial solutions:
- Reduces the size of your estate, which reduces tax liability
- Lower estate tax bill may shrink amount of insurance needed
- Protects cash value of life insurance policy from creditors
- Controls circumstances of beneficiaries’ receipt of proceeds
- Permits stronger protection/ management of proceeds to any beneficiary on government aid
ILIT Decisions to Be Made
Laws vary from state to state, so it is important to sit down with your attorney and a trusted advisor to discuss the following:
- Setting up the ILIT
- Naming your beneficiaries
- Identifying the proper trustee
- Selecting the right life insurance policy
- Shaping the circumstances for beneficiary receipt of money
Once your ILIT is set up, your advisor should help you make an informed choice on the right life insurance policy to place in the device. You may select an individual policy or a second-to-die (survivorship) policy. Remember, you do not pay the premiums directly, the trustee handles that for you.
There are smaller decisions to make in drafting your ILIT, including whether you can use an existing policy, what to do in regards to gifting and the gift tax exclusion, and if your policy avoids probate. (For related reading, see: Cut Your Tax Bill With Permanent Life Insurance.)
The Role of the Trustee
A brief word about the role of the trustee. He or she manages your ILIT and will follow your directions. Whatever money you transfer to the ILIT annually, your trustee uses it to pay insurance premiums. Your trustee handles a variety of administrative actions like the annual notification to beneficiaries and filing the ILIT’s tax return.
Discontinuing an ILIT
What do you do if you don’t wish to keep the ILIT in force any longer?
Rest assured, you are not required to continue making premium payments. Your policy may lapse as soon as you miss your annual premium payment, depending on its type. If it is a cash value arrangement, the funds may be used to pay premiums until you exhaust all the accumulated cash.
Please note: Because you cannot transfer a policy owned by an ILIT into your own name, if you think you'll ever need to tap the cash value, the ILIT may not be a smart strategy for you. (For related reading, see: Pick the Perfect Trust.)
Advisory Services offered through The Roush Group (TRG), a State of California registered investment adviser. For information pertaining to the registration status of TRG, please contact TRG or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).
No Individual should assume that any information presented or made available on or through this website should be construed as personalized financial planning or investment advice. Personalized financial planning and investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Please contact the firm for further information.
Be sure to consult with a TRG adviser and/or a tax professional before implementing any strategy discussed herein.