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Place Your Trust in Insurance and Your Insurance in Trust
While the benefits received from life insurance are not treated as income for tax purposes, if the life insurance was owned by the decedent within three years of his death, the decedent’s estate will be taxed on any amount of the insurance proceeds. above the property tax threshold. OK, now in plain English. If you take out life insurance in your own lifetime, fund the policy during your lifetime and leave the proceeds to your spouse or other family member, they will owe large taxes. So what can you do to avoid this?
Creating an Irrevocable Life Insurance Trust (or “ILIT”) will protect your family from the burden of estate taxes upon receiving the benefits of the life insurance. This estate tax savings can be accomplished either by the insurer establishing an ILIT and giving existing insurance policies to the trust, or by the trust itself purchasing a new policy on the insured’s life. The policy will be excluded from the insured’s estate because the insured will not own the policy at the time of death.
There are three requirements: (1) the insured must not own or retain any incidents of ownership in the insurance, (2) the proceeds must be payable to the trust rather than the estate, and (3) if policies are received by the insurer . to the trust, the insured must survive the gift by 3 years. To avoid any gift tax consequence, simply borrow against the existing life insurance policy for the amount of equity/value already achieved by the policy since its inception.
ILIT also provides the benefit of instructing who gets the money, at what age they get the money, and under what conditions they can get the money. For example, you wouldn’t want your 7-year-old to inherit $2 million in one lump sum. How much candy and video games do they actually need? Instead, the ILIT can name a guardian and pay for the child’s needs until the child reaches an appropriate age for inheritance, such as 18, 21 or 25. You can see that your child is cared for, but not given the opportunity. frivolously spends the inheritance.
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