Wednesday, April 20, 2005

A Non-Tax Argument for Insurance Trusts

As I was discussing with a new client yesterday, there are many reasons for an insurance trust other than tax motivations. The key reason is asset protection planning - the same reason for most any planning.

An Insurance Trust is simply a trust that own and is the beneficiary of life insurance. The proceeds from a properly structured insurance trust will be outside of your taxable estate. Most people are generally unaware that the death benefit from insurance proceeds is part of your taxable estate if you own the policy. You may not feel it today, but you may be rich when you are dead because of your insurance - so rich in fact that your insurance may create a taxable estate - and thereby inadvertently naming Uncle Sam, or Aunt NJ or NY, as your beneficiary. If the trust owns and is the beneficiary of your insurance, it will not be part of your taxable estate, although it will pass to beneficiaries of your choosing as part of your estate plan.

As a general rule, assets held in a trust cannot be reached by a beneficiaries' creditors, or by a spouse in the event of a divorce. This means you can do something for your heirs you can't do for yourself - put assets in a trust and have them beyond the reach of creditors. It also means you can do something for your kids without a fight - protect the assets you leave to them in the event of a divorce down the road.

Also, in New Jersey, a person can be a sole Trustee and a beneficiary. A Trustee/Beneficiary may only make a principal distribution from a trust for his or her benefit if that distribution is limited to health, education, maintenance or support. But a Trustee may have unlimited discretion to make distributions to other beneficiaries of the trust. For example, a surviving spouse can be the Trustee of the insurance trust, and the surviving spouse and children the beneficiaries. This allows the surviving spouse to control the investment and disbursement of the family assets, all while protecting the assets from creditor claims, children's marriages, or even the remarriage of the surviving spouse.

Another reason is one of pure practicality - insurance proceeds are paid over in large lump sum checks, and most people don't do well with large lump sum payments (think of lottery winners who are broke 2 years later). For most working people, not matter how wealthy, most of their net worth is illiquid - either because it is tied up in a non-liquid investment (like your home), or because it is mentally deemed a long term investment and therefore off-limits (like your retirement nest egg). This is not so with insurance proceeds - a claim is made and a check with a lot of zeros appears in the bank account. What would you do if you got a huge sum of money? Couple this with the fact that your beneficiaries are emotionally adrift as you have just died. Having the proceeds payable to a trust creates structure for your family going forward.

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At 4/28/2005 11:00 AM, Blogger tony s said...

Is there any downside for estate taxes to having a spouse own and be the beneficiary of a large life insurance policy. For estate tax purposes do you not achieve the same end result as with an insurance trust? The proceeds of the policy will not be consisdered part of the estate?
I would be interested in your view.
Thank you.

At 4/28/2005 6:05 PM, Blogger Deirdre R. Wheatley-Liss, Esq. said...

Great question. In short, the answer is that having your spouse own the insuarnce has no real difference from an estate tax perspective then owning it yourself. But your question made me think, and I added a new post with more comments.


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