This trust is one of the more important estate planning tools. This trust is like any other trust. It is usually irrevocable and is permitted to buy insurance as an investment. Why do you need a trust to hold life insurance? Because life insurance is not tax-free. If you owned the policy, the proceeds will be taxed in your estate. If your spouse was the beneficiary of the life insurance policy then there would be no tax because of the marital deduction. However, when the second spouse dies, 55% of the remaining proceeds could be paid in estate tax. A life insurance trust is designed to minimize these taxes.
To avoid estate taxes, the estate owner/insured has to avoid all “incidents of ownership” in the life insurance policy. The insured should not own the policy outright. The following types of “incidents of ownership” could be detrimental to the trust:
- The right to designate or change beneficiaries.
- The power to prevent a change in beneficiary.
- The option to repurchase insurance from an assignee in some instances.
- The right to borrow against the policy.