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Life Insurance Trusts
Most individuals understand the importance of carrying life insurance when they are married or have dependent children. When you take time to invest in life insurance, you have peace of mind in knowing that your loved ones will receive a lump sum, tax-free benefit. This benefit can be used to pay for funeral expenses, to payoff a home mortgage, to pay down debt, to replace a missing income, and even to pay for your child's schooling.
While life insurance benefits are not taxable, a big portion of the benefit may go towards paying federal estate taxes and other state inheritance fees. With the 2013 estate tax rate being raised to an astounding 55 percent on all estates value at $1 million or more, you can imagine just how much of a financial burden estate taxes can become for your heirs. Even heirs who have been left $1 million in life insurance may struggle to pay off debts and manage living expenses when the government asks for over half of the benefit within 9 months.
If you do not want more than half of the insurance benefit you have been paying for to be taken by the government, you need to know your options. Having a life insurance trust is the only practical way to prevent the government from taxing your insurance benefits and taking the money that was designed to help your loved ones live comfortably. Read on and find out just how a life insurance trust works and why you need one.
What is a Life Insurance Trust and What Does it Do For Your Beneficiaries?
Just like any other trust, a life insurance trust will become the owner of the policy in question. By signing over ownership to the trust, you no longer own your life insurance policy and therefore, the benefits are not subject to estate tax. With the trust in place, the beneficiaries listed on the policy will receive the full benefit amount and not just a portion of the benefit after it is taxed by the government. One individual will be named the trustee. The trustee will control the policy, distribute pay outs, and may also be responsible for managing premium payments. While there are several financial benefits, you must also consider the drawbacks to determine if setting up a trust is the best option for you.
Setting Up a Trust For Policies You Already Own
If you already own an individual life policy, setting up the policy under a trust ownership can be difficult. While it can be done, the insured party must live for at least 3 years once the trust has been established for the pre-existing policy. Because death is unpredictable, you do not know if you will survive for the three years or pass on and still be assessed estate taxes. Another drawback of setting up a trust for a pre-existing policy is that penalties and other taxes can be charged on these policies even if the insured survives more than three years.
Beneficiaries Cannot be Changed
When you set up a trust, the trust becomes the owner and the beneficiary of the insurance policy. This means that the person designated as the trustee will have control over distributing the monies to beneficiaries that have previously been designated on the trust document. Because the insured cannot be the trustee of his own policy, dealing with divorce or other family changes can be very difficult when a trust has been established. Some are hesitant to establish a trust because it lacks the flexibility that is offered by their life insurance policy.
Hiring a Trustee
While some policyholders will designate their spouses or their children as trustee, others will choose to hire a professional trustee to control the policy and handle distributions. When you hire a trustee, you do not have to worry about having a falling out with a family member you once trusted. The only drawback to hiring a trustee is that it can become costly over a long period of time. It is important to compare the cost of hiring a trustee to maintain a life insurance trust to the potential cost of estate taxes to determine if setting up a trust is practical and cost effective.
It is very important to know all of your options whenever you are planning for your future. While estate planning is a must, many people overlook specific vehicles designed to help them plan ahead. A trust may be the best option for those with large estates. For those with smaller estates, a trust may not be necessary. Review the pros and the cons of establishing a trust, compare life insurance premiums today, and design a life policy that will give your beneficiaries what they need to live comfortably long after you pass on.