When you take out a life insurance policy, we know that your ultimate goal is to provide for your family once you’ve passed away.
Especially if your family depends on your earnings to survive, you want to be certain that they have everything they need when it comes to finances.
However, you’re concerned about the potentially high life insurance tax — and you want to learn how you can help your family to keep more of their money. This post is here to fill you in on how setting up a life insurance trust can lower your overall estate taxes.
You don’t want your family to be worried about their financial future when they’re already dealing with the stress and grief of your death.
Read on to learn how to protect your family from high tax bills through a life insurance trust.
The Basics of Life Insurance Tax
First, let’s make sure that you understand your tax obligations in relation to estate planning, as the process is a bit tricky.
Yes, the death benefit — the amount of money that the beneficiary receives when the policyholder passes away — doesn’t require you to make income tax payments. You can opt to have the death benefit paid out in a lump sum, or you can choose monthly death benefit payments.
However, remember that your tax obligations often include far more than just income tax. The death benefit could become part of the overall estate value, which is taxable if they go above the standard exemption amount.
This means that the very money you hoped would help to see your beneficiaries through hard times actually ends up costing them tons of money. In some cases, especially if the tax bill is large, they may need to sell off some of your assets in order to make the payments in full.
Estate taxes are sometimes anywhere from 35-55% of the entire estate value, and beneficiaries only have about nine months after the policyholder’s death to make those payments.
Setting up an irrevocable trust is a great way to avoid these hefty tax bills and make sure everyone is provided for. Since the exemption threshold is high, usually only those who are especially wealthy can benefit from a trust fund.
Let’s talk more about how the process works now.
How a Life Insurance Trust Works
So, how exactly does a trust fund work?
In a nutshell, your life insurance policy is either transferred or sold outright to a trust.
The trust makes premium payments and then transfers over the death benefit to your selected beneficiaries once you pass away. This means that, yes, you will no longer own your life insurance policy — and that the death benefit is no longer a part of your estate.
This is an excellent way to ensure that your overall estate value falls within the federal estate tax exemption level. This means that the beneficiaries will no longer have to pay those high tax bills we mentioned above.
You’ll need to meet with an attorney to set up your trust, as well as to appoint a trustee to the trust. This is the individual or corporation who is in charge of your trust.
The majority of people who are interested in restricted property trust life insurance or any other kind of trust opt to have a financial institution, like a bank, manage their trusts.
This helps to keep potential tensions at bay.
Remember that trustees can be sued if they fail to properly manage the trust, and that, if needed, you can appoint another trustee.
Things to Keep in Mind Regarding Trusts
If you’re setting up a trust fund, there are a few specific rules and regulations that you need to be aware of.
First of all, remember that an irrevocable trust is entirely permanent. If you want to remove your policy from the trust, you’ll have to surrender it. You also won’t be able to change the beneficiary of the policy. So, you need to make certain that any family issues and contention are dealt with before setting up the trust.
You also won’t be able to borrow any money from your life insurance trust. This makes sense when you think about it, since you no longer actually own the policy.
And while a trustee is able to take loans out against the policy, doing so comes with quite a few risks. If the loan somehow helps the policyholder, the beneficiary may take legal action against the trustee.
Finally, be certain that you avoid the taxable transfer process, which could subject the beneficiaries to three years of death benefit taxation if you die three years after the transfer occurs.
Instead, just let the trust buy the policy outright.
Set up a Life Insurance Trust to Provide for Your Family
We hope that this post has made you feel much more confident about the benefits of setting up a life insurance trust.
Don’t burden your family with a high tax bill after you’re gone. Instead, get serious about estate planning and appointing a worthy trustee while you still have the time.
Looking for additional information on all things related to life insurance? Want to understand how you can improve your financial situation now, or even teach your children good money habits?
We’re here to help with all that and more.
Keep checking back in with the blog to make sure you know exactly where your money is going.
