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Avoid estate taxes by setting up an irrevocable life insurance trust

Avoid estate taxes by setting up an irrevocable life insurance trust


In 2013, the U.S. Congress approved a permanent estate tax exemption for people who have assets that total less than $5 million. Factoring inflation into the equation, that means that people today can avoid the 40 percent federal tax with as much as $5.43 million in assets.

The state of Illinois can also impose a 16 percent tax on any estate valued at more than $4 million.

Any Buffalo Grove estate planning attorney knows that cumulative assets that go above the $5.43 million federal threshold or $4 million state threshold will be taxed. Despite the federal rate hitting a record low, the Illinois rate is significantly higher than it used to be. Fortunately, people can avoid the substantial taxes by opening a life insurance trust.

How it works

As Forbes magazine points, an irrevocable life insurance trust exempt from estate tax owns the policy and grants the proceeds to a named beneficiary. The owner of the policy would open the trust and designate someone else as the trustee. The policy owner still has minor control over the policy and can ensure the premiums are paid.

The benefit of setting up such a trust is that the value of the policy is not added into the decedent’s estate. When left out of a trust, the value of a life insurance policy will be included into the gross estate subject to tax, according to the Internal Revenue Code.

Rules to consider

People who wish to avoid estate tax through setting up an irrevocable life insurance trust should be aware that they relinquish incidents of ownership upon the transfer. Therefore, they may not do any of the following:

  • Change the listed beneficiary
  • Use the policy to borrow money
  • Convert the policy

Doing any of these will negate the tax benefits.

Lastly, a Buffalo Grove estate planning attorney would advise clients that there is a catch to transferring a life insurance policy into an irrevocable trust known as the three-year look-back rule. If someone has transferred an existing policy into a trust and dies within three years of the transfer, then any proceeds from the life insurance policy are counted toward the value of the estate. If that sum comes to an amount over the federal or state threshold, the tax would be applied. However, this can be avoided if the trust itself buys a new policy.

Through careful planning, people in Illinois can avoid an estate tax through setting up one of these trusts. Anyone with questions regarding this matter should consult with a Buffalo Grove estate planning attorney.

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