The current estate tax exemption is currently set at $5.45 million. So, if your estate is worth less than $5.45 million (or $10.9 million per couple), you do not need to worry about your children or other heirs having to pay estate taxes. However, if your estate is worth more than the exemption, you can expect Uncle Sam to tax your estate worth over and above the exemption at a rate of about 40%. However, there are legal ways to reduce your estate and still insure your heirs receive more of your money after you pass. An irrevocable life insurance trust is one such device.
How an ILIT works
An irrevocable life insurance trust reduces the amount of money in an estate by taking advantage of the yearly gift tax exclusion to pay the premium. So up to $14,000 per donee ($28,000 collectively if the couple elects to split the gifts on a gift tax return) and that is per beneficiary. Meaning, if a couple has 2 children and wants them to be the beneficiaries of the irrevocable life insurance trust they could potentially gift $56,000 per year total, tax-free. Additionally, the policy proceeds are not subject to the estate/death taxes when they are paid out. So the beneficiaries of your irrevocable life insurance trust will not have to pay any taxes upon receipt of the proceeds. An added benefit is that your beneficiaries can use the proceeds to make sure there is enough liquidity to pay off any estate/death taxes.
Start with Create a Trust
Ideally, when setting up an irrevocable life insurance trust, you want to create the trust first. The donee than provides the trustee with money to place in the trust account, and the trustee uses those funds to purchase the policy and pay the premiums. As a cautionary note, if a donee buys the policy first and then has it transferred into the trust, the policy still potentially becomes part of the taxable estate if the donee happens to die within 3 years of the creation of the irrevocable life insurance trust. And, thus, defeating the purpose of creating the irrevocable life insurance trust .
If you are interested in creating an irrevocable life insurance trust to reduce your taxable estate and ensure your heirs have the liquidity they need to pay your estate taxes.
Zachary Schorr is a probate litigation attorney at Schorr Law firm in Los Angeles, California. He has researched and written extensively about real estate commercial and residential property for a decade, with an emphasis in estate planning and mortgages. Please contact real estate attorneys in California at Schorr Law, APC at (310) 954-1877 to schedule a consultation.