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Irrevocable life insurance trusts: a useful estate planning tool

Trusts can be greatly useful tools when it comes to estate planning. Part of making use of trusts for estate planning is determining what financial vehicles will be used to fund them. One option is to make use of life insurance for this purpose. One particular option is to set up an irrevocable life insurance trust. These are trusts in which the trust itself is the owner and beneficiary of life insurance policies.

When the insured individual dies, the proceeds of the policies are paid to the trustee, who manages the trust assets for the benefit of the trust beneficiaries. If the policy is owned by the insured, the proceeds are included in his or her taxable estate. The irrevocable life insurance trust avoids this by removing the policies from one's taxable estate. This allows the full amount of the proceeds to go to the beneficiary tax free.

At present, the federal estate tax exemption amount is set to be reduced to $1 million in 2013. New Jersey's estate tax exemption amount will remain at $675,000.

In addition to the benefit of estate tax savings, irrevocable life insurance trust proceeds can be used to pay estate taxes that are due, and may be protected from the trust beneficiaries' creditors. But it should also be kept in mind that such trusts cannot be amended, and that the former policy owner gives up control of the policy, and so cannot make loans or withdraw the cash value of the policy or change the beneficiaries.

Depending on who have been named as beneficiaries, there may be other considerations. In the state of New Jersey, transfers of more than $500 to nieces and nephews, for instance, are taxed at a high rate of 15 percent on the first $700,000 and 16 percent on anything over that.

These drawbacks should be carefully weighed against the benefits of using these trusts for estate planning.

Source: nj.com, "Biz Brain: Irrevocable life insurance trusts explained," Karin Price Mueller, July 22, 2012.

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