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An Overview of Estate Planning and How Life Insurance Plays a Role

February 6, 2023Filed Under: Estate Planning, Long Term Care

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When it comes to distributing your assets in your estate plan, life insurance may not seem relevant at first glance. However, life insurance can be an integral, indispensably important part of a well-thought-out estate plan. There are numerous other benefits to owning a life insurance policy aside from providing a large sum of money to beneficiaries.

  • Life insurance provides immediate cash upon death that can pay debts, final income taxes of the insured, and funeral expenses.
  • Life insurance cash can also pay estate taxes and avoid the forced sale of assets.
  • Mostly, the proceeds from life insurance will pass to the named beneficiary free of income tax.
  • Life insurance proceeds can transfer to a trust as part of a will the insured created for the benefit of minor children, special needs, or elderly relatives.
  • The proceeds of a life insurance policy can be payable to someone other than the insured’s estate and avoid passing through probate when owned by an irrevocable insurance trust. For example, the funds can pay marital settlement obligations for spousal or child support.
  • If the insured owns a closely-held business, a life insurance policy can fund a buyout of their interest.
  • Proper beneficiary designation forms of a life insurance policy prevent proceeds from going through probate.

Do not underestimate the importance of having cash funds immediately available in an uncomplicated way. Often the passing of a loved one or family member comes with a string of expenses that often exceed cost expectations. Much of what Americans have resides in investments like 401ks, IRAs, housing, and other illiquid assets with very little cash on hand. Life insurance proceeds protect families from having to force the sale of these assets at unfavorable tax rates. Some inheritable assets come with immediate payment requirements. Homes not fully paid off, cars, and the like can leave families with short-term liabilities requiring cash.

Understanding Estate Planning Strategies with a Life Insurance Policy

One of the more popular estate planning strategies that fit many situations is an irrevocable life insurance trust (ILIT). Though a beneficiary or third party cannot rescind the trust, modified, or amended post-creation, it still offers heirs several financial and legal advantages. These advantages include asset protection, favorable tax treatment, and assurance beneficiaries use the proceeds in a manner concurrent with the benefactor’s wishes. Typically, life insurance policies are the chief assets held in an ILIT.

Before purchasing a life insurance policy, particularly if you want to create an ILIT, speak with your estate planning attorney regarding potential income and estate tax consequences. If you have an estate large enough, it can be subject to federal and state estate taxes depending on the applicable laws in place at the time of your passing. Your ILIT should be in place before binding a life insurance policy to it. Remember that states have different laws regarding an ILIT; to avoid problems, your ILIT must follow your state’s rules.

Using a Gifting Strategy for your Life Insurance Plan

It is possible to gift an existing life insurance policy to your ILIT. Unfortunately, if you were to die within three years of making the gift, the policy amount can be included in your estate for tax purposes due to a rule known as a “lookback period.” In effect, this isn’t making the policy proceeds taxable, but it adds the policy proceeds amount to the total value of the estate, in turn making it part of your estate subject to taxes. As federal estate tax exemption amounts frequently change, it is prudent to fund your ILIT by purchasing a new policy. Doing so will avoid the possibility of a lookback period.

When using an ILIT, whether or not you are married, use the second-to-die, survivorship policy, or are single and have an individual policy must be considered. Choosing between variations of permanent life insurance for your ILIT, such as whole standard life, universal life, and variable life insurance, can be confusing, and your estate planning attorney can guide you to your best option.

If you own a business and one adult child will take over the business. Still, other adult children are not interested or involved in the enterprise. The life insurance proceeds can provide the cash to buy out those inheritors’ business interests while leaving the business intact. Blended family systems can also benefit from life insurance payouts to ensure that all children receive an inheritance, not just the children of the last surviving spouse.

Life insurance should be a part of your family estate plan. It can increase the wealth your heirs inherit and provide a ready source of cash for immediate financial obligations after your death. Which form of life insurance best suits your needs will depend on your age and situation. Speak with your estate planning attorney about how a life insurance policy can be an effective way to transfer wealth to your beneficiaries.

We hope you found this article helpful. If you’d like to discuss your particular situation, please don’t hesitate to reach out. Please contact our Cincinnati office by calling us at 513-771-2444 and schedule a consultation. We look forward to the opportunity to work with you.

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What is an Irrevocable Life Insurance Trust

September 23, 2021Filed Under: Asset Protection

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Since the federal estate tax exemption allowance appears to be in jeopardy of being lowered, it may be time to reconsider how you plan to pass generational wealth to your heirs. Senate Democrats are proposing to lower the current estate tax exemption from $11.7 million to $3.5 million for individuals and $23.4 million to $7 million for couples. Whether this particular Congressional bill will pass into law is unknown; however, change is likely coming to estate tax exemptions. Even without action by Congress, in 2026, the current rate will sunset and essentially be cut in half to about $6 million per individual.

Understanding Irrevocable Life Insurance Trusts and Other Taxations

To address additional inheritance taxation, many look to an irrevocable life insurance trust as a mechanism to reduce estate tax and pay your heirs part or all of the amount your estate will be taxed. The asset of the trust will be one or more life insurance policies. However, beware, as once an irrevocable life insurance trust (ILIT) is created, it cannot be rescinded, modified, or amended. There are several important requirements to create and maintain an ILIT properly, and each requirement helps to explain the nature of such a trust.

  • If you are the trust grantor, you cannot also serve as a trustee because a trustee controls the trust, leading to the trust being considered a part of your estate. It is crucial to name a trusted person or financial institution to act as a responsible trustee.
  • The trust itself must be the owner of the life insurance policy. If you transfer an existing policy to the trust and die within three years of the transfer, the policy is part of your estate due to a look-back rule. The trust can directly purchase a policy to avoid this risk.
  • The trust must pay the policy premiums, and you must transfer funds to the trust for such a purpose. This situation can create an issue with gift taxes as a transfer to a trust is not usually afforded the yearly gift tax exclusion of $15,000. To qualify as a gift for a tax exclusion, the recipient must have a “present interest” in the money. To accommodate this requirement, you can use what is known as “Crummey” power, giving beneficiaries the ability to withdraw funds transferred to the trust for up to thirty days. Sending a Crummey letter to the beneficiaries of an ILIT informs that a gift has been made to the trust, and there is an immediate and unrestricted right to withdraw those assets for up to thirty days. After thirty days, the trustee can pay the annual insurance premium with the funds. Although you run the risk that the beneficiaries will withdraw these funds, if you make it clear the financial benefit is greater in the future, it should not present a problem.
  • Generally, the beneficiary of the life insurance policy is the trust. After the funds are deposited into the trust, the trustee can distribute the assets to the beneficiaries as specified in the trust. If your beneficiaries are still minors, you can instruct the trustee to wait until they reach a certain age. Leaving the assets in the trust can also protect them from beneficiaries’ creditors.

ILIT’s can own both individual and second to die life insurance policies. All premium payments should come from a bank account owned by the ILIT. The downside to an ILIT is that it is irrevocable. However, your ILIT is a powerful tool that can minimize your estate taxes, avoid gift taxes, protect assets and government benefits, select the timeline of distribution to beneficiaries, and more. If you would like to discuss whether an ILIT may be right for you, give us a call. We would be happy to schedule a confidential meeting to discuss your needs. Contact us at 513-771-2444.

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Olivia K. Smith, Attorney at Law
Cornetet, Meyer, Rush & Stapleton Co., L.P.A.
123 Boggs Lane,
Cincinnati, Ohio 45246
Tel: (513) 771-2444
Fax: (877) 483-2119
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Olivia K. Smith, Attorney at Law
Cornetet, Meyer, Rush & Stapleton
123 Boggs Lane
Cincinnati, OH 45246
Phone: 513-771-2444
Fax: 877-483-2119
oksmith@cmrs-law.com

Family Law Attorney Olivia K. Smith, LLC represent clients in Cincinnati, Anderson Township, Batavia, Loveland, Mason, Milford and other communities in Hamilton County, Clermont County, Butler County and Warren County.

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