How Trust-Owned Life Insurance Can Be Used Effectively In Your Estate Plan
What if I told you, with complete certainty, that you will die one day. Would you believe me? Of course, you would. But, is it something you want to talk about? Of course not! As uncomfortable as it is to think about, death is inevitable, and planning for it is often overlooked due to fear and uncertainty. Too many people don’t plan; if you don’t have a plan, the government has one for you, and I can assure you that your heirs won’t like it. Sure, your family, heirs, and loved ones need to be taken into consideration while planning your estate, but in cases of large estates, things like gifting, taxes, charitable giving, and legal documents take priority to efficiently and effectively transfer your estate when you ultimately pass.
I want to share with you a tool that has been a cornerstone of many of my clients’ plans and utilizes many benefits that they (and you) are able to take advantage of.
How It Works
Many high net worth individuals often wonder about the best way to create a seamless estate plan. Though there are many options, trust-owned life insurance (TOLI) has been proven to be very beneficial, as it enables the trust to provide for the beneficiaries by balancing inheritances among the heirs estate tax-free, which is one of the top issues among wealthy individuals. This strategy is also beneficial for individuals who desire to give to charity upon passing. The trust-owned life insurance strategy works well for those of high net worth, who have illiquid assets (such as businesses or qualified plans), and who live in states with large state death taxes.
When an individual purchases a life insurance policy, it can often be most beneficial to have their irrevocable life insurance trust (ILIT) own the policy. An ILIT is an irrevocable trust designed to own life insurance. By utilizing this strategy, assets owned by the trust are able to pass to the beneficiaries according to the grantor’s wishes, without being subject to federal estate taxes. This is possible because the owner is the trust, which now removes the proceeds from the insured’s estate. The trustee then maintains the policies, which opens up the family to a variety of important tax planning and charitable giving opportunities. At death, the death benefit proceeds will be paid to the designated beneficiaries of the trust income and estate tax-free, as the trust is no longer owned by the estate. The premiums are typically funded by annual exclusion gifts but can also be funded by using private financing or premium financing.
Advantages of Trust-Owned Life Insurance
This strategy can not only help achieve effective tax planning but also allows for the proceeds to provide liquidity to help the estate pay expenses and taxes once the grantor passes away. This liquidity opportunity is available due to a provision that allows the trust the discretion to purchase assets from either spouse’s estate or to make loans to either estate, which keeps cash available for estate liquidity purchases.
Additionally, an ILIT gives an individual the opportunity to donate to 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 made to the ILIT will reduce the overall value of the estate, which will, in turn, reduce the amount that would be calculated in the taxable amount.
Potential Pitfalls of the Gifting Limitations
If you are thinking about gifting to your life insurance policy, you should be aware of the gift tax liability. In 2018, any gift that is greater than $15,000 for the year ($30,000 for married couples) applies against the gift tax exclusion and requires that Form 709 be filed.1 The maximum premium you would be able to gift without gift tax liability would be $30,000. Many times, this just won’t suffice to properly plan one’s estate.
Avoid Gifting Large Premiums to Your Life Insurance Trust
Many people need large policies that require much more than what the annual gift exclusion allows to cover their needs. This is where premium financing can be a valuable tool and has helped countless clients of mine achieve financial success in retirement.
How It Works
Premium financing is a planning strategy that enables you to pay the premiums for the coverage you need without having to liquidate assets. It involves an arrangement through which you borrow money from a bank to pay for your life insurance policy.2 The policy’s cash value is generally used as the majority of the collateral for the loan.
By leveraging a lender’s capital, rather than your own, to pay annual premiums, you can retain your capital in other investments. The loan could be paid off from a portion of the death benefit proceeds upon the death of the insured(s), a tax-free withdrawal from a portion of the cash value, or an asset sale in the future.
Premium financing can be a valuable tool for those who want to maximize their estate with a substantial life insurance death benefit and without having to liquidate and pay taxes on other investments in order to pay large premium payments. Premium financing also avoids using up your annual gift exclusions and reducing your overall lifetime exemptions. When the death benefit is paid to the trust, it is generally paid income and estate tax-free, leaving more for your heirs.
While premium financing can be an advantageous strategy for some, it does have associated risks. For example, lending rates may increase more than projected, which may require collateral to be posted with the bank. If securities are posted as collateral, and those securities decrease in value, the lender may require additional collateral to be posted.
Putting It in Perspective
Imagine having a thriving family business that you would like to leave to your heirs, or maybe you want to leave your children a substantial piece of land. In your estate planning, however, you discover that your estate will be subject to a $10 million tax bill. The only way for your estate to pay this tax liability, in the absence of additional advanced planning, may be to sell the family business or land you wish to pass on. You don’t want your family or heirs to be forced into a fire sale, where they have to take any offer just to liquidate as quickly as possible. Fortunately, there is another way to address these potential liquidity needs.
Life insurance can be both a tax-efficient and cost-effective source of funds for addressing these issues. Many high net worth individuals use life insurance and trusts in their overall estate plan to help preserve their estate from tax liabilities and other expenses. To pay for these large premiums, life insurance premium financing may be an attractive option. If you are attempting to use any of the above strategies, it’s important to let an experienced and independent life insurance agent and attorney help you navigate the nuances.
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