Thursday, April 28, 2005

Life Insurance Owned by the Spouse - an Alternative to the Insurance Trust

A question has been raised about the estate tax consequences of having a spouse own and be the beneficiary of a life insurance policy. Is this a way to successfully avoid estate tax? How does this compare to an Insurnace Trust? As with all things, the results depend on the facts.

Example: Husband (H) and Wife (W) are married with 2 young children. H is purchasing a term life insurance policy for $1 million dollars. The policy is intended to (i) pay off the mortgage if H dies, (ii) provide for college education for the children, (iii) provide for income replacement, if necessary. H and W live in New Jersey, where there is only a $675,000 exemption from estate tax. Including the insurance death benefit, H and W collectively have assets in excess of $1.5 million dollars.

H owns the Insurance and names W as the beneficiary. The insurance death benefit is includible in H's taxable estate. However, since the death benefit all passes to W, and there is no tax due on assets passing to a spouse courtesy of the unlimited marital deduction, there will not be any tax due. However, the problem with this scenario is that if W dies shortly after H, without having spent any of the insurance proceeds, then the $1 million is includible in her estate, and will be subject to estate taxes as her exemption is insufficient to cover the proceeds and the other assets.

W owns the Insurance and W is the beneficiary of the policy. The estate tax result is the same as above. H dies and W receives the insurance proceeds. W's taxable estate is now increased. If W dies shortly thereafter, the insurance proceeds are subject to estate tax - not in H's estate, but in W's estate. Another wrinkle is that W owns the policy regardless of H and W's continuing relationship - if H divorces W, W owns a $1 million policy on H's life, and H can do little about it; not a comfortable thought.

H owns the Insurance and names his Estate as beneficiary; A credit shelter trust is created in the Will. Here, H avoids the divorce scenario and may generate some additional tax savings. If the Insurance policy funds his credit shelter trust, H is ensuring that his exemption from estate taxes is fully utilized at his death; thus reducing the amount of assets that W's estate needs to shelter at her death. Even if W died shortly after H, the insurance proceeds payable to the estate and allocated to the credit shelter trust would not be subject to tax in W's estate. However, there is a risk in making your insurance payable to your estate - your probate estate (i.e. assets controlled by your Will when you die) is subject to the claims of your creditors; life insurance proceeds payable to a named beneficiary generally are not. Thus, if you have debts when you die (mortgage, credit cards, margin loan, unpaid taxes....); or there are claims against your estate as a result of your death (wrongful death from a car accident), the insurance proceeds payable to the estate must be used to satisfy those claims before it can be set aside for your beneficiaries.

W owns Insurance and names children and beneficiaries. This is a scenario to be avoided at all costs. Where W owns the insurance, H is the insured, and children (or anyone other than W) are the beneficiaries, then upon H's death, W is deemed to have made a gift of the full amount of the death benefit to the children - a taxable gift in our example. Also, the children now have the insurance proceeds - W does not. W does not have a right to those funds merely by virtue of being their mother.

An Insurance Trust is created to own the Insurance. H creates an insurance trust naming W and the children as beneficiaries of the trust. Since the proceeds are owned by and payable to an irrevocable trust, they are not including in H's estate. When W dies, she is merely a beneficiary of the trust, so the insurance proceeds are not included in W's estate. Since the insurance proceeds are not passing through the Will, they are generally not subject to the claims of creditors. W can be Trustee, and distribute the funds appropriately among W and the children. There are other non-tax benefits (see 4-20-05 post - A Non-Tax Argument for Insurance Trusts). The downside to the Insurance Trust are set-up fees and annual maintenance through a separate bank account and properly issuing contribution notices.

Conclusion - There is no right answer. If your spouse survives you for a long time and spends the insurance proceeds, the estate tax consequences are negligible. Making your estate the beneficiary may give you tax savings without the costs of creating another trust. However, given that insurance is a huge cash inflow that should be protected from the possibilities, investment in an Insurance Trust may be the best way to accomplish your goals.

Bookmark and Share

24 Comments:

At 12/19/2009 11:45 AM, Anonymous Life Settlements New York said...

This is an interesting blog post, thnaks for the post...

 
At 4/25/2011 2:03 PM, Blogger Peter said...

This type of insurance policy is one type of permanent life insurance. With a permanent policy, the insurance is designed to last as long as you pay the premiums. Whole life insurance guarantees this lifetime protection. Universal life does not have these guarantees but there is now a term life insurance quote where you can add a feature that guarantees that the insurance will last the rest of your life.

 
At 6/23/2011 3:08 PM, OpenID Wilson O'Doyle said...

Hey Peter I took your advice and got a Term Life Insurance Quote. I was happy with the result.

 
At 12/21/2011 1:31 PM, Blogger mike said...

After my last life insurance quote i got i don't know how the average working class can afford the extra money for life insurance

 
At 2/18/2014 9:15 PM, Anonymous Oklahome Health Insurance said...

Having insurance in married status, it should both have the right to know all the beneficial covered with the insurance and also things didn't cover. Before you go any to insurance you should get a health insurance quotes for example.

 
At 5/21/2014 12:37 AM, Blogger Mohammad Junaid said...

This comment has been removed by the author.

 
At 5/21/2014 12:38 AM, Blogger Mohammad Junaid said...

Life insurance offers the best alternative solution for loss of income due to the death of a family member.Its value will be established in its well-planned life.You can search online for adequate Insurance company or Independent Insurance Agent for you.

 
At 6/24/2014 7:33 AM, Blogger agen sbobet said...

A great job you have already done. I’m really delighted to see your amazing work.whole life insurance for seniors

 
At 6/25/2014 5:59 AM, Blogger Mike tyson said...

I have been really impressed by going through this awesome blog. car insurance quotes comparison

 
At 7/22/2014 7:44 AM, Blogger deny lost said...

The information you have given in the blog really marvelous and more interesting. affordable whole life insurance

 
At 9/12/2014 2:58 AM, Blogger deny lost said...

Great blog post! I don’t understand how long it will require me to obtain through all of them! auto insurance

 
At 11/02/2014 9:57 PM, Anonymous Law blawgger said...

Thanks so much for this post! There is a lot of really helpful information here, keep up the great work1

 
At 11/17/2014 1:00 AM, Blogger Transcend said...

Thanks for the read. My Insurance Find

 
At 11/25/2014 5:46 PM, Anonymous getting life insurance said...

Thanks so much for this article, it has really helped me and my family.

 
At 12/12/2014 6:13 AM, Blogger Mike Tyson said...

This is one of the most important blogs that I have seen, keep it up!home insurance miami

 
At 1/05/2015 2:57 PM, Anonymous Tate Turner said...

Thanks so much for this post! I just started doing some research on this and this has been the most helpful thing I've found yet. Keep up the great work here!

 
At 1/08/2015 5:20 AM, Blogger Enrich John said...

The caliber of information that you're offering is merely wonderful.http://www.LogMeOnce.com

 
At 1/12/2015 1:20 AM, Blogger Jennifer Lawrance said...

The caliber of information that you're offering is merely wonderful.watch brands

 
At 4/13/2015 2:24 AM, Blogger Nathan Rider said...

I love this blog because it is user friendly with appreciative information.life insur

 
At 7/08/2015 5:40 AM, Anonymous maria lucy said...

Very innovative thought.This article are very helpful for us.I think this blog are really interesting.
Thanks for sharing info
auto insurance

 
At 9/03/2015 2:44 AM, Blogger JeorgeSmith said...

Thankfulness to my dad who informed me relating to this blog, this website is really amazing.life insurance quotes

 
At 6/01/2016 8:23 AM, Blogger chandu said...

Good one ! How ever This is a scenario to be avoided at all costs. Where W owns the insurance, H is the insured, and children (or anyone other than W) are the beneficiaries, then upon H's death, W is deemed to have made a gift of the full amount of the death benefit to the children

work injury compensation

 
At 9/26/2017 5:26 AM, Blogger Colva Services said...

This comment has been removed by the author.

 
At 9/26/2017 5:47 AM, Blogger Colva Services said...

Thanks for the blog post! Irrevocable Life Insurance Trust is non-amendable, means once it is settled no changes can be made on it. But you can closely control many other aspects of the ILIT. You can dictate who your initial beneficiaries will be and define the terms under which they will receive benefits. You can choose the Trustee (or Trustees) who will manage your ILIT but these advantages can only be taken only if you have designed your policy carefully.

 

Post a Comment

<< Home