Many people don’t realize that the proceeds of a South Florida life insurance policy will be added to your estate for estate taxes if the policy has been owned by the deceased during their last 3 years of life. This is the case for more than 90 percent of all life insurance policies. Although the beneficiary is not taxed directly on the proceeds, as of 2011, the estate is taxed at 55 percent. Usually, the beneficiary of the life insurance policy is also the representative of the estate. This means that the government can tax your family if your plan is not well structured.
Because of the huge tax implications, an Irrevocable Life Insurance Trust (“ILIT”) is very useful for real estate planning in South Florida. An ILIT is a legal instrument prepared by a South Florida estate planning attorney for the purpose of removing life insurance from your estate to reduce taxes and increase asset protection. You can designate your spouse, child or other suitable party as the beneficiary of the trust.
You can also provide detailed directions to the ILIT trustee, including how the life insurance payout should be distributed, when the trustee should make payments, loans, or investments, what to do with the family business, who will receive the assets upon death or disability of your original beneficiaries, and when to terminate the trust. The ILIT gives you control over the money from beyond the grave and protects your children from undue liability.
As you can see, structuring your life insurance policy so that the ILIT preserves the life insurance payout is helpful in achieving a number of goals, including:
1. limitation or abolition of inheritance tax;
2. increasing the assets available to your spouse, children and other loved ones or entities after you are gone; and
3. providing extra liquidity to an estate or company in financial distress.
Since the ILIT is a separate legal entity in South Florida that is outside your estate, the IRS cannot levy an estate tax on the assets within the ILIT because you have no control over them. Since you are able to write down all your goals and wishes in the trust document, and because your life insurance policy is normally the only asset in the trust during your lifetime, it makes sense to give up control in return. for all tax benefits. The trustee is the applicant, owner and beneficiary of your life insurance policy, so the proceeds will never go through your taxable estate and the estate tax will be reduced by 55 percent of the total life insurance payment.
Owning your spouse or child and acting as the beneficiaries of a South Florida life insurance policy on your life is another way to avoid the estate taxes on your life; however, the ILIT has the added benefit of also excludes undistributed proceeds from your beneficiaries’ taxable estates. Well-planned ILITs will limit or eliminate multi-generational inheritance and cross-generational taxes.
An ILIT can also help you increase the assets available to your beneficiaries as it makes it easy to own one or more life insurance policies. The South Florida Trustee has the trust document as an efficient roadmap to follow regarding the purchase, premium payments, and proceeds distribution. The ILIT brings money into your estate by making distributions, purchases or loans as necessary. The trustee of the ILIT makes appropriate distributions of cash proceeds to cover debts, taxes and funeral expenses. The trustee could even buy some or all of the business with the cash proceeds and run the business professionally until the kids were old enough to take over. The trustee can also make appropriate loans to the spouse, children and the company.