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Life Insurance Beneficiary: Trust?

Home Estate Planning Life Insurance Beneficiary: Trust?

  • Avatar Docbeans 
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    Status: Physician
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    Hi all,

    How do we word who should be the beneficiaries in our life insurance policies?… Of course, the answer differs for everyone, but if one wants to designate spouse as primary beneficiary and kids as contingent/secondary beneficiaries, do you word it as such or if you have a living trust, can the trust be designated as the beneficiary? Is there any benefit to this?… does this avoid the problem of probate? If so, can trust be named primary or secondary beneficiary… after spouse? Making the assumption here that the trust also has a similar flow… spouse, then kids, then xyz.

    Thanks in advance!

    #21702 Reply
    jfoxcpacfp jfoxcpacfp 
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    There are several moving parts to your question.

    • Generally, life insurance proceeds are not taxable for estate and state tax purposes. However, because a trust is not a person, naming a trust as beneficiary means the proceeds will be included in your estate.
    • If you believe you will have a taxable estate, an ILIT (Irrevocable Life Insurance Trust) may be in order
    • As for the “problem of probate”, to what are you referring? Probate is typically not the complicated process that the folks who promote (and sell) setting up Living Wills make it out to be.
    • Make sure you name a human beneficiary for the insurance policy and that no insured owns his/her own policy. Otherwise, this will also subject the proceeds to taxation.

    All of the above points deserve a full-length discussion and research as applicable to you.

     

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #21713 Reply
    Liked by Docbeans
    OSUDent OSUDent 
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    Status: Dentist
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    Joined: 03/19/2016

    There are several moving parts to your question.

    • Generally, life insurance proceeds are not taxable for estate and state tax purposes. However, because a trust is not a person, naming a trust as beneficiary means the proceeds will be included in your estate.
    • If you believe you will have a taxable estate, an ILIT (Irrevocable Life Insurance Trust) may be in order
    • As for the “problem of probate”, to what are you referring? Probate is typically not the complicated process that the folks who promote (and sell) setting up Living Wills make it out to be.
    • Make sure you name a human beneficiary for the insurance policy and that no insured owns his/her own policy. Otherwise, this will also subject the proceeds to taxation.

    All of the above points deserve a full-length discussion and research as applicable to you.

     

    Click to expand…

    Could you expand on the bolded part for me? As in, I have a life insurance policy, but I shouldn’t technically be the owner? If so, who should be, the beneficiary? Thanks.

    #21723 Reply
    jfoxcpacfp jfoxcpacfp 
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    Make sure you name a human beneficiary for the insurance policy and that no insured owns his/her own policy. Otherwise, this will also subject the proceeds to taxation. All of the above points deserve a full-length discussion and research as applicable to you.   Could you expand on the bolded part for me? As in, I have a life insurance policy, but I shouldn’t technically be the owner? If so, who should be, the beneficiary? Thanks.

    Click to expand…

    If you are the owner of your own policy, it will become a part of your taxable estate when you die. Your spouse should own the policy on you and she can be the beneficiary. You can also put the policy into an ILIT.

    So, to choose the owner and beneficiary, your intents matter. Are your children the beneficiaries of your policy? A solution is for spouses to own each others’ policies. Of course, if divorce is a possibility, that may not be the best option.

    This only matters if you will have a taxable estate or estate/inheritance taxation on the proceeds at the state level.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #21725 Reply
    Scott at MD Financial Services Scott at MD Financial Services 
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    If you own a policy personally and you have a spouse as a beneficiary on it there is no tax regardless of transfer amount, that is unlimited on the transfer….you can have a $100 million dollar policy that you own personally, name your spouse as the Beneficiary and at death of you, the insured, there is no taxes due on that or any other money you give your spouse.  Now if you want to prevent the taxes being due on the spouses assets at death (above the then current federal estate tax threshold) then having a life policy owned and beneficiary back to ILIT is ideal as you can have your spouse and children be the beneficiary of that ILIT so they have access but it is out of your estate from an ownership standpoint.  Keep in mind there is a contemplation of death rule that essentially states if you transfer ownership of an existing policy to an ILIT and then you pass away in the next 3 years the government will consider that to have still been in your estate.  In some situations that is still ok to do, others is it is better to buy a new contract with the ILIT being the owner from the start so there is no ‘ownership contamination’ to deal with.

    S. Scott Nelson-Archer, CLU, ChFC with M. D. Financial Services, Inc.
    Direct Phone 713-966-3932, Email [email protected]

    #21729 Reply
    jfoxcpacfp jfoxcpacfp 
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    Thanks for stepping in, Scott – much more comprehensive answer!

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #21730 Reply
    Avatar TheGipper 
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    Status: Physician
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    Joined: 01/20/2016

    Scott & Johanna.

    We are a family of 6, with four young kids. We have a living revocable trust and sizable life insurance policies. Our estate planning lawyer advised us to make trust the contingent beneficiary. Spouses are primary beneficiaries. I understand the risk of taxation to estate should we both die, but what is the other option for contingent beneficiary, just name to minor children?

    Is there a way to construct or amend a living revivable trust to avoid taxation in this scenario similar to how a trust can be set up to preserve stretch IRA even if trust is named a beneficiary.

    #21752 Reply
    jfoxcpacfp jfoxcpacfp 
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    Understand that with a life insurance policy, the contingent beneficiary is rarely needed. If you divorce, you will change the primary beneficiary. If you die, the policy will pay out and terminate. If you both die at once, then the insurance pays out to minor children (the contingent beneficiaries) and the guardian becomes of great importance. To plan for this situation, I would recommend a trust for the proceeds and a different trustee than your choice of guardian. However, the proceeds would be subject to estate taxation in a RLT.

    Another option for you might be an ILIT (Irrevocable Life Insurance Trust), which would keep the proceeds out of your taxable estate but I will defer to your estate planning attorney. ILIT’s are more complicated and, as I’m sure you understand, you are planning for an event that is highly unlikely. If the policies alone would subject your estate to taxation (over $10.9M), and ILIT might be the better solution. Otherwise, by the time you are worth enough to have an estate tax problem in the event of a joint death, your kids will likely be adults. Again – your estate planning attorney almost surely has more expertise in this issue than do I.

    Scott?

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #21781 Reply
    Scott at MD Financial Services Scott at MD Financial Services 
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    I am certainly not going to tell you to do something against your attorneys advice since I am not one.  Having a revocable trust is all about having a document with specific direction on what to do with the money that would move to the desired place outside of probate, Johanna mentioned dealing with probate is not really that big of a deal most of the time so I would hope for multiple reasons other than probate as to why a revocable is right.  However, I have to admit that I have never heard of having a revocable but then not naming it the primary Beni, that is odd and I don’t have a clue why they would suggest that to you.  Certainly if you have a sizable insurance policy that between that benefit amount and the assets you have would put you over the estate tax limit then I would recommend speaking to your attorney about drafting a Irrevocable Life Insurance Trust (ILIT), make your spouse probably the trustee, spouse and kids the beneficiaries of the trust, place the premium for the policy in a bank account owned by the trust, allow it to sit for 30 days while you send out Crummy letters (that is from Crummy vs. the US in tax court), then once the 30 days are up then you can have a new policy issued in the trusts name or you can transfer ownership of an existing policy into it (remember 3 year rule if you do this, see prior post), now pay the premium via the trust account.  By doing this you have now moved the ownership of the policy outside of your estate so when that benefit gets paid out it is paid to the trust tax free and the trustee of the ILIT can distribute the funds however they want per the guidelines of the trust.

    In my opinion you get 3 great things out of this trust.  1:  Outside of your estate so having a large death benefit does not get reduced due to estate taxes (keep in mind you have to be over $10 million and some change today for a couple to be into estate taxes).  2: If that money is left in the trust then that money is outside of the clutches of any creditors that might come along to the beneficiaries personally.  3:  The final thing that is great is if that money is left in the trust then any future marriages of the beneficiaries that end in divorce can not get to the asset.  Please let me re-state I am not an attorney and I am not saying this trust is for you but generally speaking that is the way it works and maybe you should speak to your attorney about this as an option.

     

    S. Scott Nelson-Archer, CLU, ChFC with M. D. Financial Services, Inc.
    Direct Phone 713-966-3932, Email [email protected]

    #21784 Reply
    Avatar TheGipper 
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    Status: Physician
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    Thank you Scott.

    But if I understand correctly naming the living revocable trust as the primary beneficiary would make the life insurance proceeds taxable in absence of ILIT, no?

    #21807 Reply
    jfoxcpacfp jfoxcpacfp 
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    Thank you Scott.

    But if I understand correctly naming the living revocable trust as the primary beneficiary would make the life insurance proceeds taxable in absence of ILIT, no?

    Click to expand…

    They would be part of your taxable estate but only if you have a large enough estate. The proceeds would not be taxable, i.e. for income tax purposes.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #21808 Reply
    Scott at MD Financial Services Scott at MD Financial Services 
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    Johanna is 100% right.  You can make anyone and any amount of a life insurance policy the Beni and that is 100% INCOME tax free.  The value will be looked at from an estate issue so that is why we sometimes use trusts to own policies, business (key person insurance), or business partners (buy / sell agreements for business partnerships)….all in the attempt to get the value of a ‘Matured’ (means you died) life policies death benefit proceeds paid but not have them count in your estate.

    S. Scott Nelson-Archer, CLU, ChFC with M. D. Financial Services, Inc.
    Direct Phone 713-966-3932, Email [email protected]

    #21809 Reply
    Avatar TheGipper 
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    Status: Physician
    Posts: 407
    Joined: 01/20/2016

    Thank you guys. For now seems like I should:
    1) make trust primary beneficiary
    2) later look into ILIT or alternative
    3) get a new estate planning lawyer

    #21814 Reply
    jfoxcpacfp jfoxcpacfp 
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    Thank you guys. For now seems like I should:
    1) make trust primary beneficiary
    2) later look into ILIT or alternative
    3) get a new estate planning lawyer

    Click to expand…

    Sounds like the start of a plan but if you’re changing estate planning attorneys, I would put this step first and have him/her involved in your amendments.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #21819 Reply

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