Life insurance plays a very important part in many estate plans, but proper ownership is critical. Many people are not aware that if you are the owner of a policy on your own life, the death benefit is includable in your taxable estate. If you have substantial life insurance, you may want to review alternative ownership possibilities or create an Irrevocable Life Insurance Trust (ILIT) to help family members manage the proceeds and potentially reduce estate taxes.
In a nutshell, an ILIT provides for survivorship needs and orderly distribution of proceeds. This trust can be used to provide an annual income to the survivor and at the same time secure an estate for heirs. An ILIT can also help you to control the distribution of the proceeds. For example, instead of getting all the proceeds at one time, you could have your heirs receive them in installments.
Liquidity. The funds placed in an ILIT can be used to ensure that your estate has sufficient cash to pay any estate tax that may come due. At the time of your death, the life insurance proceeds will be paid into the trust. Because the estate may need these proceeds to pay estate taxes, the proceeds will need to be moved from the trust to the estate. This can be accomplished by loaning the proceeds to the estate, or by having the trust buy assets from the estate.
Wealth Replacement Trust. A common technique is to use an ILIT in conjunction with a Charitable Remainder Trust to replace the value of assets given to charity. This can result in your beneficiaries receiving much more than if you had sold the asset yourself and had paid both capital gains and estate taxes.