Life Insurance Trusts

By Fiore, Nicholas | Journal of Accountancy, July 1994 | Go to article overview

Life Insurance Trusts


Fiore, Nicholas, Journal of Accountancy


Life insurance is a vital part of many estate plans. It can help solve many problems that may come up, including maintaining liquidity, providing a source of income for surviving spouses or heirs and funding buy-sell agreements among the owners of closely held businesses.

LIFE INSURANCE PROCEEDS

If payable to or for the benefit of an insured's estate, life insurance proceeds generally are included in his or her estate. The tax consequences depend on the concept of "incidents of ownership" (defined below): If the insured retains incidents of ownership, he or she still is considered the policy's owner.

Incidents of ownership include

* The power to change the beneficiary.

* The power to surrender or cancel the policy.

* The power to assign the policy.

* The power to revoke an assignment.

* The power to pledge the policy for a loan against its surrender value.

* The power to obtain a loan from the insurer against the policy's surrender value.

* The power to retain any of these rights if the beneficiary dies before the grantor or if certain other contingencies occur (also known as a reversionary interest).

* Control of the trust's terms or the payout of income to the beneficiaries (that is, in a fiduciary capacity).

* Ownership of a corporation that is the policy's beneficiary.

USE OF TRUSTS

If properly designed, a trust will be treated as a separate entity from the insured. At the same time, if the proper provisions are included in the trust agreement, the insured still can achieve his or her estate planning objectives, and avoid estate (and maybe even income) taxes.

LIFE INSURANCE TRUSTS

If an individual wishes to establish a trust to own and hold insurance on his or her life for someone else's benefit, certain issues must be considered and resolved.

Inter vivos. The trust should be set up during the insured's lifetime; if established as part of the individual's will, it will not be effective in removing the proceeds from the insured's estate.

Irrevocable. The trust should be irrevocable. If it can be revoked by the insured, the grantor effectively retains control over it. …

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