What Is Trust-Owned Life Insurance (TOLI)?

Trust-owned life insurance (TOLI) is a type of life insurance that resides within a trust. TOLI is an estate planning tool mainly consumed by high-net-worth individuals, who rely on it to ensure the responsible distribution of inheritance assets among their heirs, reduce estate tax liability, and meet their charitable objectives.

Key Takeaways

  • Trust-owned life insurance (TOLI) is a type of life insurance housed inside a trust. 
  • TOLI is favored by high-net-worth individuals who use this tool for estate planning needs.
  • The assets housed within the trust that are bequeathed to beneficiaries can sidestep onerous tax obligations.
  • TOLI policies demand regular reviews to make sure they adequately meet the current needs of the trust. If not, the products should be replaced with superior offerings.

Understanding Trust-Owned Life Insurance (TOLI)

It is important that the trust-owned insurance policies are reviewed regularly because existing policies may not adequately meet the current needs of the trust. Newer insurance products might be more cost-efficient while offering better options and features.

If you expect your estate value to exceed the exemption amount, or if the calculation is still unpredictable and you wish to cover your proverbial bases, it may be wise 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 that they can remain income and estate tax-free. But there are potential disadvantages to parking these assets in a trust. The most glaring one is the loss of control. While a trustee is named to carry out the instructions of the trust, the grantor is effectively relinquishing ownership of the life insurance policy.

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Life Insurance

In cases where a life insurance policy isn’t initially established within the trust but is later transferred into it, it’s critically important to remember that 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. Consequently, those assets will be subject to estate taxation. This is why it's generally prudent for individuals to conduct this type of planning in their 60s or 70s, rather than waiting until they're much older.

Advantages of Trust-Owned Life Insurance

When a life insurance policy is owned by an individual's ILIT, the assets housed within the trust are funneled to the beneficiaries, as per the grantor’s directives, without onerous federal estate tax obligations. This is because the owner is actually the trust, which effectively omits the proceeds from the estate of the insured party.

Gifts made to ILITs shrink an estate's value, thus diminishing any associated tax burdens.

Furthermore, a provision of this structure affords the trust the flexibility to make loans to either spouse's estate or to purchase assets from either estate in order to create the liquidity needed to pay estate taxes and other expenses. Finally, ILITs let philanthropically-minded individuals donate funds to their pet charitable causes, while protecting inheritances for their loved ones by providing a death benefit that replaces the value of the charitable gifts.