512-655-2186 pam@haileypettylaw.com

It’s smart to have a life insurance policy to help your family in the event that you pass away suddenly. It can help keep your family in your home and pay for college tuition.

One aspect of life insurance that folks don’t think about is the fact that the proceeds from their life insurance policies are part of their estate for estate tax purposes when they pass away. This can create some issues with estate taxes.

family-510The way to avoid this is to create an irrevocable life insurance trust or an “ILIT.” The ILIT will assume ownership of the policy and remove it from your taxable estate during your lifetime. That means that the proceeds won’t be counted towards your lifetime exemption from federal estate taxes of $5.34 million. That may seem like a lot of money and a long way’s off, but assets can add up quickly, and you’ll want to take advantage of every break you can to lower the value of your estate so that more money goes to your heirs and less goes to the IRS.

How to Avoid Estate Tax with an ILIT

An ILIT can be especially beneficial if you have a large life insurance policy. Removing that big policy from the estate tax valuation and the consequences is critical to maximizing your assets for your family and loved ones.

The State of Texas doesn’t have an inheritance tax, so there’s no death-related taxes owed to the state. But there is a 40% federal tax on any estates over the $5.34 million threshold. Keeping your estate from hitting that mark is the benefit of an ILIT.

A life insurance trust is an irrevocable, non-amendable trust that is the owner as well as the beneficiary of one or more life insurance policies. When the insured (you) dies, the trustee of the ILIT will invests the proceeds from the policy and will administer the trust for the beneficiaries.

After speaking with Pam and creating your ILIT, you’ll be able to transfer the ownership of your life insurance policy from you to the trust or purchase the policy in the name of the trust. An important component is deciding who will serve as the trustee. You can have a financial institution or a family member serve in that capacity, but it should be someone other than yourself.

Who Gets the Proceeds?

When you create an ILIT, you’ll name the trust as the insurance policy’s primary beneficiary so that the proceeds from the policy are deposited straight into the ILIT. That money is held in trust for the benefit of the its beneficiaries, whom you named in the ILIT formation documents.

Note that if you want to have the proceeds held in trust for the benefit of your spouse instead of going straight to him or her from the insurance company, he or she will get regular payments instead of a lump sum. The nice thing about this is that the life insurance proceeds also can’t be taxed as part of the spouse’s estate.

Potential Pitfalls

Of course there’s always some fine print to read when we talk about taxes.

In the event that you pass away within three years of transferring your life insurance policy to your ILIT, the IRS will go ahead and include the proceeds in your estate for estate tax purposes. The way to work around this is to have the trust purchase the policy on your life and then fund the trust with enough money to pay the premiums.

Gift taxes are also a concern as you’re, in essence, giving the trust the money to pay for the policy. However, an experienced estate planning like Pam can help you avoid this, too.

Remember that an ILIT is irrevocable, meaning that once you create and fund it, it can’t be undone. But since ongoing premiums have to be paid to keep the life insurance policy in effect, cancelling the trust is as easy as not making premium payments. As a result, there would be nothing in the trust when the policy lapses.

Consider these points regarding Irrevocable Life Insurance Trusts and then speak with Pamela Hailey-Petty by contacting the Hailey-Petty Law Firm in Austin at (512) 655-2186 or email pam@haileypettylaw.com. She can help you with any follow-up concerns you have and make sure your estate plan is effective and comprehensive for your sake as well as your family’s.

Your family’s future is our business.