By Dr. James M. Dahle, WCI Founder
There is a type of trust that protects your assets, helps with your estate planning, and helps minimize taxes. Unfortunately, it comes with a very big caveat. That caveat is that it is irrevocable. That means once you put assets into it, they are no longer yours and are governed by the rules of the trust. But there are times when you still might want to use it. Here's how it usually works:
You have substantial assets. You're 100% positive you're not going to need them to provide financial support for you during your life. You're worried creditors might get them and you're also concerned about exceeding the estate tax exemption ($5 Million under current law). So what you can do is put the assets into an irrevocable trust while you're still alive. Anything you put in the trust is protected from your creditors, because it isn't yours any more. Remember the gift tax laws allow you and your spouse to “gift” up to $13,000 a year each to anyone or anything you like without invoking “gift taxes” (a reduction in your $5 Million exemption). So the two of you can put a total of $26,000 a year into the irrevocable trust without reducing your exemption useable at death. If you do this every year for a decade or two before you die, you can substantially reduce the amount of your estate at death, perhaps even to the point where the estate won't owe estate taxes at your death.
Life insurance proceeds are income tax free. They are not, however, estate-tax free. If your estate is $4 Million and you also have a $2 Million life insurance policy, upon your death you'll owe estate taxes on $1 Million unless it is left to your spouse, which just delays the issue. One way to get around this issue is to put the policy inside the irrevocable trust. In fact, many people actually start a trust, then have the trust buy the policy on you. Since it is a policy that you want in force at the time of your death, not just for a specific period of time (term), you would buy a permanent life insurance policy, such as whole life. Now, whole life usually isn't a very good investment, but for the right person, it can have HUGE tax advantages with regards to the estate tax.
So what people do is buy as big of a whole life policy as they can buy for their age and health for a premium of up to $26,000 a year. They also often buy “second to die” type policies that only pay when the second spouse dies. This allows for a larger benefit and/or a lower premium to maximize the benefit. Upon the death of the second spouse, the trust receives the proceeds of the policy, which is then distributed to the heirs in accordance with the rules of the trust, free of both income tax and estate tax. Now, it sounds great to avoid all those taxes. But trusts, of course, have expenses, as do life insurance policies (especially permanent life insurance policies.) So this isn't a good idea for everyone, but it IS a great idea for those whose estates exceed the current estate tax exemption limit (currently $5 Million per spouse, or $10 Million total.)
One strategy is to use a credit shelter trust to get the full $10 Million exemption, then use gifts to an irrevocable life insurance trust to keep the estate under $10 Million. I don't anticipate ever having an estate bigger than $10 Million, but you might. Also, Congress might reduce the exemption amount at any time. It wasn't very long ago that the exemption was only $1 Million per person.
Learn more about estate planning here.
have you considered creating forums for discussions? maybe it would attract more attention over the long haul.
Given the relatively low number of comments and a number of good forums out there for both finance and physicians, I’m not sure I’m ready to go there, aside from the fact that I really don’t want to spend much time moderating. There’s nothing more pathetic than a barely used forum.
A friend of mine is a tax attorney and she structures things like this for high net worth individuals. She mentioned that these things weren’t worth it for anyone w/ less than 20 mil in investable assets that they could throw into such a thing due to the setup and maintenance costs.
Curious to see what you guys have heard…
The set-up and maintenance are significant, and now with the ability to pass on $10M without estate tax costs, there is less benefit. I don’t know that you need $20 million to get a benefit. It seems there would be a lot of benefit right around $10M to me. Below that? Probably not as much.
New to the website. Great information. Most of the discussion is focused on federal estate taxes. I would check first if your state assesses its own estate taxes. If the answer is no and you don’t anticipate an estate over $5 million (or $10 million with properly designed revocable living trust and credit shelter trust as noted above), then don’t bother getting an ILIT (irrevocable life insurance trust). In New Jersey, the estate tax limit is $675,000 and assessed as high as 16% (as I recall). With a $2 million life insurance policy, an ILIT can potentially avoid over $200,000 in NJ estate taxes. Cost of ILIT roughly $2,000-2,500 (as far as I recall, as my wife and I did it with my will/living revocable trust 10 years ago), a relatively small expense compared to potential estate taxes. Maintenance so far negligible. Requires trust tax ID number (my lawyer applied to IRS for me), a dedicated trust checking account (bank may take couple of weeks to review trust papers), Crummey letters (annual letters to your trust beneficiaries, signed by them, that they waive their financial gifts to pay for the insurance premiums; an IRS tecnicality) and a reliable trustee (in my case, my brother for my ILIT). Though technically irrevocable and out of your control, you choose the trustee as grantor (who unofficially will do your bidding if you choose wisely), or if you decide that your children do not deserve your financial largess, you can stop funding the ILIT.
In 1994 I was 40 yrs old…I set up a Crummey irrevocable life insurance trust and bought a 1 million dollar variable univeral life policy from northwestern life….I had to put 36,000 into the policy when i bought it, transferred the 36k from other policys cash values i had……..premium is 13,000 a year….now its 2013 I’m 59 yrs old and the cash value in the policy is 235,000…I also had a cola rider for 10yrs in it…the DB is 1.4 million…I plan on paying the premium for another 10 yrs….I have the cash value invested in only 2 stock funds…..fidelity contra and fidelity equity income…..both doing very well……Just thought i’d post what i have done…….