Life insurance has long been a useful estate planning tool, allowing liquidity to a bereaved family at the most critical moment when a bread winner may be newly deceased with resultant loss of income. For younger families, with children depending on the parents, life insurance can make the difference between poverty and a continuation of a middle class life style, between children going to college or children forced to work immediately after high school.

Life insurance can also provide liquidity for buy and sell agreements for business buyouts, for an “automatic” savings plan if they develop cash value, and to provide businesses some cash flow if a key executive dies.

It is vital to have trusted advice as to which of the myriad types of life insurance are appropriate for the particular circumstances of the individual or business and which make sense from a cost benefit analysis. A good broker who knows that the purchase is the beginning of a long professional relationship is an important tool for the person seeking to purchase life insurance that is truly useful and appropriate.

Equally important for family estate planning is to make sure the life insurance does not end up included in the decedent’s estate for estate tax purposes. If held incorrectly, life insurance can result in estate tax being incurred and up to half the value of the insurance can end up being paid to the government instead of the beneficiaries.

A useful structure to avoid that danger is the Life Insurance Trust which is the subject of this brief discussion.


The Basics

The reader should first review the article on Wills and Trusts for a synopsis of what a trust is. The reader should recall that there are two types of basic trusts: revocable and irrevocable. Irrevocable means that the person who creates the trust (the “trustor”) is not allowed to revoke the trust: the transfer of assets into that trust is a completed gift to a separate entity which pays its own taxes and, from the point of view of the United States taxing authorities, is as much a “tax paying” person as any other person in the United States. Revocable trusts, which can be terminated at the discretion of the trustor, are usually ignored by the taxing authorities. They conclude that if the trustor can revoke at will, there really is no separate taxable entity and simply tax the trustor for the assets in the trust as if no trust had been created.

If a life insurance policy is owned by the decedent at the time of his or her death or, in many circumstances, by the decedent’s spouse, it can be included as part of the decedent’s estate. While the level of estate tax varies with other estate planning tools and while the level of estate tax changes each year, it is quite possible that this could result in taxes being levied against the life insurance in excess of forty percent. A million dollar policy could be reduced to six hundred thousand and, depending on the State, even less.

But if an irrevocable trust is created to own the life insurance and the trustee of the trust is not subject to the effective control of the trustor, the life insurance is not included in the decedent’s estate. Usually, the trustee is not in the trustor’s family or an employee of the trustor (so as to avoid the taxing authorities claiming that the trustee is actually no more than the alter ego of the trustee and ignoring the trust entity entirely.) The trustor contributes sums from time to time to the trust sufficient to purchase the life insurance and keep it in effect. The trustee then uses the funds to maintain the insurance. The terms of the trust instruct the trustee as to his or her duties, as explained in the article on Wills and Trusts.

After the trustor’s death, the life insurance is distributed to the trust and the trustee, pursuant to the trust instrument, is required to pay it out, with no estate tax, to the designated beneficiaries of the Trust, usually the children of the trustor, or to hold it in trust until the children reach a certain age or to pay their college education.

Assuming the correct terms of the trust have been drafted and obeyed, the distribution will be free of estate tax.


As with any irrevocable trust, it is important BEFORE the document is executed, to make sure it provides for precisely the desires of the trustor. Remember, once the trust is created and funded, it is truly irrevocable and the trustor no longer has any right to reclaim the assets or control them other than as described in the trust instrument which, by its very nature, will not allow the sums to go back to the trustor since otherwise the tax benefit would never have been achieved.

Or, as one client put it, “This is show time and one way, isn’t it?” as he executed the Trust. Another client put it with less concern: “Making an irrevocable trust is like creating a new person…who does what I want.” “Yes,” I responded, “within limits…but like with any person, once they leave your full control you can’t just call them back to mother…”

Thus appropriate drafting and a close consideration of the benefits and detriments of the transfer must be carefully considered. While avoiding taxes are important, it is vital to note that if there is any chance the funds could be needed again by the trustor, the gift may not makes sense. An examination of the entire estate planning…and financial planning…goals of the trustor must be undertaken before it is decided to use these clearly valuable tools.


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