Life insurance is a potentially useful tool in estate planning, and can be used for a variety of purposes such as ensuring an estate has enough liquidity to manage its debts and funding trusts. One specific way to use life insurance is to establish an irrevocable life insurance trust. In using life insurance trusts, though, there are a number of pitfalls to avoid and things to keep in mind.
One thing to be aware of when using life insurance in estate planning is that life insurance policies must be transferred to life insurance trusts according to established rules. One of these rules concerns what is known as the “look-back period.” In order to gain the tax benefits of the transfer, the grantor must do it within three years of his or her death. When the policy is created before or with the purchase of the trust, the trust can be listed as the original owner and beneficiary of the beneficiary of the trust. Alternatively, the one can gift an existing policy to the trust, which later purchases the policy.
Ongoing maintenance of a life insurance trust is important, particularly making premium payments. These payments can be made through a non-interest bearing checking account. Another option is for the grantor to help make the payments by transferring money into the trust checking account as a gift. When this is done, the grantor must provide the beneficiaries with special notice, if the trust allows the beneficiaries to withdraw the gift.
Since life insurance trusts are irrevocable, they cannot be modified. When the terms of the trust no longer serve the needs and wishes of the parties, the options for taking things in a new direction are more limited. What can be done, though, is to decant the trust and distribute the trust property into another trust with the preferred terms. Another option is to simply establish a new trust.
Any estate planning involving life insurance trusts should be done with the guidance of an experienced attorney and financial planner. DIY estate planning can be done, but there are more likely to be significant errors and oversights.
Source: Wealth Management, “Top 10 Considerations for Estate Planning with Life Insurance,” John McManus, October 29, 2013.