Insurance Trusts Handout - Penn Mutual Life

Life Insurance for Estate Liquidity
Insurance Trusts
Death creates an immediate need for cash to pay living expenses for your family and the claims
against your estate: expenses of last illness, funeral & burial costs, estate settlement costs, federal
& state taxes, debts & other claims against your estate, etc. Life insurance can provide the necessary
cash for your estate at a cost of pennies on the dollar, and with proper planning, policy proceeds
can be received tax free - no federal estate tax or state death taxes, no federal or state
income taxes, no capital gains tax.
Insurance policy proceeds paid at death generally are not subject to federal income tax, regardless
of who is the owner and beneficiary of the policy. However, insurance proceeds will be
included in the insured’s gross estate, and may be subject to federal estate tax of up to 47%, if the
proceeds are paid to the insured’s estate, or if the insured is the owner of the policy or has any
"incidents of ownership": the right to designate or change the policy beneficiary(s), the right to
surrender or cancel the policy, the right to assign the policy or revoke an assignment, the right to
receive policy loans or pledge the policy as collateral, etc. In order to avoid federal estate tax on
life insurance proceeds, two effective planning techniques are irrevocable life insurance trusts and
survivorship standby trusts.
Irrevocable Life Insurance Trusts
An irrevocable life insurance trust is one created during the grantor’s lifetime, and the grantor
does not have the right to terminate or modify it during lifetime. The trust is the owner and beneficiary
of life insurance on the grantor, spouse, or other members of the grantor’s family. The
insurance policies can be existing ones that are transferred to the trust, or they can be new policies
that are purchased by the trust. In either case, policy premiums are paid by the trust with
funds that are given to it by the grantor or other family members. If the trust is properly drafted
and administered, federal gift taxes on the funds transferred to it to pay policy premiums can be
minimized or eliminated altogether. At death, the policy proceeds are paid to the trust income
tax free and estate tax free, and the trustee is given the power to make loans to the grantor’s
estate or purchase non-liquid assets from the estate, thus providing the estate with the necessary
cash to pay taxes and settlement costs.
Creates trust
“Crummey”
withdrawal
rights
Beneficiary(s)
During Lifetime
Grantor
Trust
Gifts money
for premiums
Pays policy
premiums
Insurance Co.
Sells assets
to trust
Pays policy
proceeds
Insurance Co.
At Death
Grantor’s Estate
Trust
Loans to
Estate
Income and
principal
Beneficiary(s)
P LANNING FOR A S ECURE F INANCIAL F UTURE
Created by The Penn Mutual Life Insurance Company, 600 Dresher Road, Horsham, PA 19044
Over

Advantages of Irrevocable Life Insurance Trust
• Policy proceeds received by the trust income tax free and estate tax free.
• Provide cash for estate settlement costs.
• Provide income to family members.
• Professional management of policy proceeds and other trust assets.
• Avoid probate administration and maintain confidentiality regarding trust assets.
• Protect policy proceeds and trust assets from creditors.
• Minimize gift tax consequences with "Crummey" withdrawal rights in trust beneficiary(s).
Survivorship Standby Trust
A survivorship standby trust is a variation of the traditional irrevocable life insurance trust that is
funded with a survivorship ("second-to-die") life insurance policy. Survivorship life is a type of policy
that insures two people, generally spouses, under a single policy, and the death benefit is not
paid until the death of both insureds or the last survivor between them. In a typical estate plan
for a married couple, no federal estate tax will be payable until the death of the surviving spouse.
Survivorship life was designed to be "synchronized" with the federal estate tax because the death
proceeds are not paid until the death of the surviving spouse. If the survivorship policy is owned
by an irrevocable trust, the policy proceeds generally will not be subject to federal estate tax, but
there are some disadvantages:
• Loss of control over policy - insureds can’t be trustees.
• Insureds can’t access policy cash values during lifetime.
• Trust can’t be changed or terminated if circumstances or goals change.
• Funds transferred for premiums may be subject to gift taxes.
• "Crummey" beneficiary(s) might withdraw funds against insureds’ wishes.
A survivorship standby trust (SST) is designed to accomplish two objectives: permit the insureds to
retain lifetime control over a survivorship life policy and have access to policy cash values, and
avoid federal estate tax on policy proceeds paid at death. Here’s how it works: the spouse with the
shorter life expectancy due to age, sex, health, etc. (generally the husband) applies for and owns a
survivorship policy on both spouses. The policyowner-spouse creates a survivorship stand-by trust
under the terms of his/her Will, and the SST is designated as the contingent owner and beneficiary
of the policy. Basically, an SST is an irrevocable life insurance trust that doesn't begin to operate
until the policyowner’s death. During the joint lifetime of the insureds, the policyowner pays
all premiums, and because the policy is owned outright, the policyowner-spouse has unrestricted
access to policy cash values. At the policyowner's death, the policy is transferred to the SST, which
begins to function as a conventional irrevocable life insurance trust. If the non-policyowner
spouse dies first, the policyowner-spouse can continue to own the policy outright, or transfer it to
an irrevocable trust or other third party (children, etc.) during lifetime to avoid inclusion of the
proceeds in his/her gross estate.
Advantages of Survivorship Standby Trust
• Income-tax-free & estate-tax-free proceeds for estate liquidity.
• Elimination of gift tax on premiums paid during policyowner’s lifetime.
• Income tax deferral on growth of policy cash values.
• Policy cash values may be received during policyowner’s lifetime for for retirement, college
funding, or other lifetime needs.
P LANNING FOR A S ECURE F INANCIAL F UTURE