United States: Life Insurance Trusts

First poublished in Legal Advisory, Vol. 7

Many life insurance policies (especially term insurance) have little or no value during your lifetime. Therefore, the gift of a life insurance policy often has no gift tax consequence. Also, because term insurance does not have a cash value, a lifetime gift of term insurance has no taxable consequences. Upon your death the proceeds of the insurance policy are included in your federal estate and therefore subject to taxation. If you transfer ownership of a policy to an irrevocable life insurance trust and live three years after doing so, the proceeds of the life insurance policy at death will not be included in your estate, or the estate of your spouse, and therefore cannot be subject to taxation. Also if the insurance is initially acquired by the trust, rather than transferred to the trust after the policy has been issued, the proceeds will not be taxed in either you or your spouse’s estate, regardless of whether or not you live three years after purchase. A popular form of life insurance for clients in the federal state area is insurance which pays a death benefit only upon the death or the survivor of two individuals, such as a husband and a wife. Under tax-efficient estate plans this would be the time when the estate taxation may come into existence and therefore the insurance proceeds would be available to cover this expense. The use of two individuals, both insured usually 1) extends the time period during which the insurance company retains and invests the policy premiums and 2) substantially reduces the risk of an unexpectedly early payment of the death benefit. Therefore, insurance companies are typically able to offer a much higher death benefit for a survivor life insurance policy, sometime referred to as "last to die" policy, as opposed to the standard insurance policy. Federal estate taxation of a life insurance policy can be avoided if the policy is properly placed in an insurance trust.