What is Trust-Owned Life Insurance (TOLI)
Trust-owned life insurance is life insurance that resides inside a trust. Trust-owned life insurance is used by many high net worth individuals as the cornerstone of their estate plan. It enables the trust to provide for survivors, cover estate tax liability planning, balance inheritances among heirs and meet charitable objectives.
BREAKING DOWN Trust-Owned Life Insurance (TOLI)
Life insurance is viewed as a long-term asset that will not be used for its true purpose, ideally, for decades. Consequently, it is often overlooked when monitoring and managing the overall trust. However, it is important that the trust-owned insurance policies be reviewed regularly. The existing policy might not meet the current needs of the trust, and newer insurance products might be more cost efficient and offer better options and features.
If you expect your estate value will be over the exemption amount, or if the calculation is still unpredictable and you wish to cover your bases, it may be a good idea to establish an irrevocable life insurance trust (ILIT) and have the trust own your life insurance policies. This would remove the insurance proceeds from your estate completely, so they can remain income and estate tax free.
However, there are some potential disadvantages to owning assets in a trust. The most glaring disadvantage is the loss of control. While there is a trustee named to carry out the instructions of the trust, the grantor is effectively relinquishing ownership of the life insurance policy.
In cases where life insurance policy isn’t established inside of the trust and is transferred into it, it’s important to remember there is a three-year look-back period. If you die within those three years, the insurance proceeds will be considered part of your estate and subject to estate taxation. This is why it usually makes sense to do this type of planning in your 60s or 70s rather than waiting until you are older.
Advantages of Trust-Owned Life Insurance
By having one’s life insurance owned by their ILIT, it allows assets owned by the trust to pass to the beneficiaries according to the grantor’s wishes, without being subject to the federal estate taxes. This is possible because the owner is the trust, which now removes the proceeds from the insured’s estate. It also allows for the proceeds to provide liquidity to help the estate pay expenses and taxes once the grantor passes away. This is possible, due to a provision, which allows the trust the latitude to purchase assets from either spouse’s estate, or to make loans to either estate, which keeps cash available for estate liquidity purchases.
An ILIT also gives an individual the opportunity to provide for a charity, while preserving an inheritance for their chosen beneficiaries. The ILIT provides a death benefit that replaces the value of the gift made to charity. Furthermore, the gifts that are made to the ILIT will reduce the overall value of the estate, which reduces the amount that would be calculated in the taxable amount.