You have purchased a life insurance policy as an added protection for your loved ones, so that they can live comfortably after you are gone. Why not, then, carry that a little further by protecting that important payout from taxation, so your family can have every penny that you intended?
If you are married and have named your spouse as the beneficiary of your life insurance policy, those proceeds will pass free of both income taxes and estate taxes. However, if you have named your children as beneficiaries, those proceeds are free of income tax, but they do become part of your taxable estate. Minnesota’s estate tax kicks in at $1 million, and it’s easy for life insurance proceeds to push the estate over the limit. If your estate does get taxed, it’s a big bite.
An Irrevocable Life Insurance Trust (ILIT) is a great asset protection tool that protects your life insurance proceeds from estate taxes, and when drafted properly, can also be used to protect those proceeds from your beneficiaries’ creditors, bankruptcy, and divorce.
So, why should you do this? The life insurance proceeds are not part of your estate if the ILIT owns the life insurance policy. Therefore, those proceeds are not subject to estate tax when you die.
The best way to use this kind of trust is to have the Trustee of the life insurance trust purchase the policy directly and pay all premiums. If you have not yet purchased life insurance, you should create your ILIT first, and then have your Trustee purchase the life insurance. In this case, you can avoid the difficulties that can arise when you transfer life insurance from you to another party if you do unexpectedly pass away, since the proceeds of your life insurance policy would revert to your estate if you died within three years of the transfer.
If you already own the life insurance policy, your ILIT Trustee can either buy the policy from you, or you can transfer it into the trust, by following certain rules we can help you with. It’s not as ideal as purchasing a policy anew from within the ILIT, but it is nonetheless a great way to shelter those proceeds from taxation, provided you live more than three years after the transfer.
The ILIT is a great tool for allowing you to leave behind more for your loved ones.
To put the proper legal and financial protections in place for your family, contact our office at (612) 206-3701 or fill in our contact form to schedule a time for us to sit down and talk.
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