Insurance Trusts

INSURANCE TRUSTS generally are irrevocable trusts designed to remove taxable value from one's estate. For example, Settlor establishes an irrevocable trust designed to be funded with life insurance proceeds at his death. Settlor names his son as trustee of the trust. Settlor contributes funds into the trust and the trustee purchases a life insurance policy on Settlor's life. Each year the Settlor makes a gift into the trust and the trustee uses the money to pay the premiums on the policy. At Settlor's death, the death benefit proceeds flow into the trust and the trustee will use the trust funds as Settlor has directed in the trust document. Often such trusts are designed to assist children or grandchildren with college expenses, the purchase of a car, a down payment on a home, medical emergencies.

These types of trusts may be designed to take advantage of the annual gift tax exclusion amount. The contribution into the trust each year is sheltered by the gift tax annual exclusion and therefore does not reduce the Settlor's applicable estate tax exclusion. These type of clauses in such a trust are called "Crummey" provisions taking their name from a court decision.

If a Settlor knows for sure that his or her estate is going to be subject to federal estate tax, one immediately thinks about this technique as a way to lower the taxable estate without gift tax consequence.

To indicate just how valuable a technique this can be, consider this example. Husband and Wife have a substantial estate and are sure their estate is going to be impacted by federal estate tax. They establish an irrevocable insurance trust and name their son and daughter as co-trustees. They make a gift of cash into the trust and the trustees purchase a second-to-die life insurance policy on the Settlors. The trust provides that at the second death, the life insurance proceeds flowing into the trust will split into four equal shares for Settlor's four grandchildren. The trust provides that such shares remain in further individual trusts for each of the four grandchildren. The trustee at any time may invade income or principal for the grandchild's health, education, support and maintenance. When the grandchild turns 21 the trustee is instructed to start distributing all net income of the grandchild's trust to the grandchild. When the grandchild turns 25 he or she is to receive 1/4 of the trust, 1/2 of the remainder at 30 and the remainder at 35.

From a tax point of view, Settlors have used assets which would otherwise been subject to federal and state death taxes and reduced their taxable estate with no corresponding reduction of the applicable federal estate tax exclusion. Moreover, they have done so with no gift tax consequence since the gifts made into the trust were under the annual gift tax exclusion allowance. The death benefit which flows into the trust is not included in the taxable estate of either Settlor, nor is it subject to income tax at the trust level since it is insurance. Additionally, since it was second-to-die insurance, Settlors have received more death benefit for their premium dollar flowing into the trust.

From a non-tax point of view, Settlors have taken funds which otherwise would have been subject to estate tax and segregated it irrevocably to assist their grandchildren in the future. Limiting language regarding invasion of principal in the trust document is important because it gives the Trustee ample leeway to turn down requests for unwise distributions. Limiting language creates a double-edged sword in the hands of the trustee. For a good reason the trustee can say "yes." For a bad reason the trust can say "no." For example, granddaughter requests funds from her trust to travel around the world with a heavy metal band (which perhaps under the circumstances the trustee considers unwise). Answer: No. Instead, granddaughter requests funds for college. Answer: Yes.

Contact us to discuss establishing an Irrevocable Insurance Trust as part of your estate plan.