Taxes can be quite the burden, especially when it comes to life insurance and the estate that you want to leave for your children. As much as possible, you want to give them the amount in full so that they can use and maximize it for their living expenses and savings.
Life insurance policies are great, considering that it is income tax-free, there is no capital gains tax, and the policies do not claim any income. It’s the most ideal way to leave money to your loved ones.
Life insurance, however, is subject to Minnesota estate tax. If the estate is large enough, it can be subject to federal state tax. This will reduce what you can leave to your survivors. Some States would have estate tax exemptions that exempt some estates from taxes if they don’t meet the minimum taxable amount. But for those that do, it becomes more and more burdensome to pay for estate taxes.
However, there is a way to avoid estate taxes altogether. That is through an irrevocable life insurance trust.
Irrevocable Life Insurance Trust
Regular life insurance policies would have an individual as the owner of the policy, hence making the insurance part of his or her estate. In an irrevocable life insurance trust, on the other hand, the individual is not the owner of the policy. Instead, it is named under a trust.
Because of this, the individual, along with other people who own the trust, would have to manage the policy together, pay the premiums, etc. Because an irrevocable life insurance trust is not owned by an individual person, it doesn’t become part of the estate and hence will not be subject to estate tax, income tax, or capital gains tax. It’s a completely tax-free life insurance, except for gift tax which can easily be bent or avoided.
Another perk of having an irrevocable life insurance trust is the level of control that the policy holders have. There is a lot of flexibility as to what an individual wants to do with the life insurance policy. They can stipulate that it be given to their kids when they reach a certain age, or that a portion of the amount should be given to the grandkids, etc.
An irrevocable life insurance trust is a great way to avoid taxes. But at the same time, it’s a very powerful tool. Anyone interested in it should talk to a lawyer to help them navigate and set up their irrevocable life insurance trust perfectly.