Life Insurance Trusts

At Frankel Sims Law, we often recommend insurance trusts as a way to keep insurance proceeds out of the taxable estate. If you think that you could benefit from an insurance trust, please feel free to contact us to discuss whether an insurance trust would be a useful tool in your estate plan.

Many people do not realize that life insurance proceeds are often subject to estate tax at the death of the insured. Ownership of a large life insurance policy, even an inexpensive term policy, can have unintended adverse estate tax consequences if the policy’s death benefit, combined with the insured’s other assets, exceeds the $3,000,000 Maryland or $5,490,000 federal estate tax exemption limits.

Transferring ownership of life insurance policies to a life insurance trust is a relatively easy way to keep the life insurance proceeds out of your taxable estate at death. A life insurance trust is an irrevocable trust which is both the owner and beneficiary of one or more life insurance policies. Upon the death of the insured, the trustee invests the insurance proceeds and administers the trust for one or more beneficiaries.

Proper ownership of life insurance is important if the insurance proceeds are to escape estate taxation. If the policy is owned by the insured, the proceeds will be subject to estate tax. (This assumes that the aggregate value of the estate plus the life insurance is large enough to be subject to estate taxes.) To avoid estate taxation, some insureds name a child, spouse or other beneficiary as the owner of the policy.

There are, however, two drawbacks to having insurance proceeds paid outright to a child, spouse or other beneficiary.

  • Doing so may be inconsistent with the insured’s wishes or the best interests of the beneficiary, who might be a minor or lacking in financial sophistication and unable to invest the proceeds wisely.
  • The insurance proceeds will be included in the beneficiary’s taxable estate at his or her subsequent death.

The solution to both problems is usually an irrevocable life insurance trust. It is best if an insurance trust is created prior to the purchase of an insurance policy so that the trust can purchase the policy directly. If the insured transfers an existing policy to the insurance trust, the transfer will be included in the insured’s taxable estate if the insured dies within three years of making the transfer.