If you are married you may need additional tax planning beyond your A-B living trust as was previously explained to you if your estate is over $1,300,000. If you are single, this planning applies if your estate is over $650,000 (as of 1997 the Federal Estate Tax Exemption was raised from $600,000 to $650,000 in 1999 and is scheduled to be gradually raised to $1,000,000 by the year 2006).

Keep in mind that these are in addition to your living trust. This will not replace your living trust. Your living trust is the foundation for all of your estate planning needs.

Notice, too, that this planning involves a trust that is irrevocable. A living trust is revocable—remember, it can be changed or cancelled at any time as your needs change. An irrevocable trust, on the other hand, cannot be changed or cancelled once the final document has been signed. If you decide to use this in your estate and tax planning, make sure you read the document very carefully and that you completely understand it before you sign anything.

THE IRREVOCABLE LIFE INSURANCE TRUST

Most people own some amount of life insurance and there are very good reasons for doing so at all ages. When you are young, life insurance can provide for your family in the event you die prematurely. Life insurance can also be very valuable later in life—to provide income for your family, to provide funds to buy out a business, or to pay estate taxes.

However, many people don't realize that these life insurance proceeds, while not subject to probate proceedings (unless, for some reason, you name your estate, not your trust, as the beneficiary), are included in your estate when determining Federal estate taxes (life insurance proceeds are not subject to the lower Ohio estate tax, 2% to 7%, again, unless you name your estate, not your trust, as the beneficiary). Depending on the amount of insurance you have, this can dramatically increase the value of your estate—and the amount of Federal estate taxes that must be paid.

An irrevocable life insurance trust lets your beneficiaries benefit from the insurance proceeds and keeps the value of the insurance out of your Federal taxable estate, potentially saving your family tens or hundreds of thousands of dollars in Federal estate taxes. How? Very simply, the life insurance trust owns your insurance policy for you. And since you don't personally own the insurance, it won't be included in your Federal taxable estate when you die. (Sound familiar? The concept is basically the same as a living trust and how it avoids probate.)

If you are single and your net estate—including your life insurance—is more than $675,000, or if you are married and your total estate is over $ 1.35 million, an irrevocable life insurance trust is something you should seriously consider. If your estate is less than this, it is exempt from estate taxes so it doesn't matter if you are the owner of the policies. You just need to name your living trust as the beneficiary of your insurance.

Let's look at a couple of examples:

Let's say you are single and, after subtracting out loans and debts, your net worth is $675,000 in "regular" assets (real estate, stocks, etc.) plus you have $200,000 in life insurance. The value of your estate would be $800,000 and when you die, $75,000 will be due in Federal estate taxes. (Remember, the rate starts at 37% for each dollar over $675,000—and it goes up from there, up to 60%!).

On the other hand, if you have an irrevocable life insurance trust, the trust (not you) would own the insurance, so it would not be included as part of your estate. Your taxable estate, then, would only be $675,000, equal to the $675,000 exemption you are allowed. The life insurance trust just saved you $75,000 in Federal estate taxes, leaving that much more for your beneficiaries.

Here's another example. Let's say you are married and your net estate is $1.75 million, $450,000 of which is in life insurance. With an A-B living trust, remember, you can shelter $1.35 million from Federal estate taxes. The remaining $400,000 will be subject to Federal estate taxes of approximately $153,000. However, if you also have an irrevocable life insurance trust, this $400,000 will not be included in your estate—and that means about $153,000 more for your beneficiaries and not for the IRS.

Your Federal taxable estate will include all life insurance proceeds for which you have any "incidents of ownership" as defined by the IRS. Basically, you would have an incident of ownership if you pay premiums or control any use of the policy, such as being able to change the beneficiary(ies), cancel the policy, borrow against it, assign it or revoke an assignment, pledge the policy for a loan, or have a reversionary interest (control) of more than 5% of the value of the policy immediately before your death (meaning you, not your named beneficiary, retain control over who will receive the proceeds if your beneficiary dies before you).

For example, your employer may provide life insurance as a benefit. You don't own the policy (your employer does), but you can name the beneficiary and change it at any time. The amount of this insurance, then, would be included in your taxable estate when you die. The ability to change beneficiaries creates this "incident of ownership." "Death benefits" from a fraternal organization or lodge would also be included in your estate for Federal estate tax purposes.

You could give away the ownership of your insurance to someone else—this would keep the insurance out of your taxable estate without setting up a life insurance trust. But this can also be risky.

Let's say you make your spouse owner of your insurance. You can't be sure which of you will outlive the other, and if your spouse dies first, the cash (surrender) value of the policy would be included in your spouse's taxable estate. Also, ownership of the insurance would revert to you. So that doesn't help much. There may also be a gift tax involved. And if you die within three years of changing the ownership, the transfer will be considered invalid by the IRS and the insurance will become part of your taxable estate.

But, perhaps more importantly, when you give someone else ownership of your insurance, you are giving up all control over the policy. The new owner can change the beneficiary(ies), take the cash value, even cancel the policy and leave you with no insurance. You may think you can trust this person now, but there could be some problems later if you were to have a major disagreement or, in the case of your spouse, if you divorce.

Setting up an irrevocable life insurance trust is a much safer alternative. It will let you make sure the proceeds are distributed the way you want and avoid estate taxes by removing all incidents of ownership.

When you set up the trust, you will name a trustee to manage the trust for you. Following the instructions in your trust, the trustee will purchase a life insurance policy with you as the insured and the trust as the owner of the policy. In most cases, the trust will also be the beneficiary of the policy. So when the insurance benefit is paid after your death, the trustee will collect the funds and distribute them as you have instructed to your beneficiaries—without probate, income taxes or Federal estate taxes.

If you name your trust as beneficiary, the insurance company will pay the proceeds to the trust and your trustee can then use the funds according to the instructions you put in your trust. For example, your trustee could purchase assets from your living trust, replacing hard assets with cash to pay income and estate taxes, preventing a distress sale of the assets.

Also, if one of your beneficiaries is incompetent when you die, your trustee can invest that beneficiary's share and provide for his/her care for as long as needed. If you had named this person as a beneficiary of the life insurance policy, the insurance company probably would not pay to him/her direct, insisting instead on court supervision through a conservatorship.

Just like your living trust, you can name anyone you want as beneficiaries of your insurance trust, and you can put any restrictions you want on the distributions. For example, you may want to provide for your children's or grandchildren's education, then distribute the remaining proceeds among all your beneficiaries. You may also want to provide your estate with cash to pay estate taxes.

Where does the trustee get the money to purchase the insurance? From you, but in a special way. If you give the money directly to the trustee, it could be subject to a gift tax. You also want to make sure you avoid any incidents of ownership in the policy to keep it out of your estate. So here's what you can do.

You may already know that each year you can give away up to $10,000 to an individual or organization with no gift tax. (If you are married, you and your spouse together can give up to $20,000.) That means you can give up to $10,000 each year ($20,000 if married) to each beneficiary of your insurance trust. But instead of making the gift directly to the beneficiaries, you give it to the trustee of your trust. Using the form letters supplied with your trust documents, the trustee then notifies each trust beneficiary that a gift has been received on his/her behalf and, -unless he/she elects to receive the gift now (the beneficiary is given a one-time 30 day right of refusal for each gift), the trustee will invest the funds—by paying the premium on the insurance policy.

This is called a demand right because your beneficiaries are sent a written notice by the trustee giving them the opportunity to demand the gift. When they decline, they forfeit this right. (The notification is also called a Crummey letter, because the procedure was proved valid in a case successfully brought against the IRS by a Rev. Crummey in 1968.) Of course, for this to work, your beneficiaries need to be informed and understand not to take the gift now, waiting instead for the insurance proceeds. By using this approach, you can make sure you have no incidents of ownership in the policy.

To allow you to gift the full $10,000 annually (or $20,000 by husband and wife) per beneficiary, your trust will have an additional provision. That's because if a beneficiary of your insurance trust refuses a gift from you that exceeds $5,000 or 5% of his/her individual share of the trust, the excess is considered to be a gift by that beneficiary to the other beneficiaries. This gift does not qualify for the $10,000 gift tax exclusion, so your beneficiaries would have a gift tax liability.

To solve this problem, your insurance trust will be divided into separate shares, one for each of your beneficiaries, with the trust assets (the insurance policy) allocated among the shares. Then, when a beneficiary refuses a gift from you that exceeds this 5 & 5 limitation, the beneficiary is making a gift of the excess to himself/herself—not to the other beneficiaries. This eliminates any potential gift tax liability.

Having the trustee purchase new insurance on your life is the best way to fund your trust and make sure you have no incidents of ownership in the policy. And the best type of life insurance for a married couple is a second to die policy. Because you are insuring two lives instead of one (that means there is statistically more time before the policy pays out) the premiums are much lower. Also, a second to die policy is not used to support the surviving spouse after the death of the first spouse, so it does not deprive the surviving spouse of needed support when used in this way. But you can transfer existing policies into your trust, although it is somewhat more complicated and risky. That's because of the "three year of death" rule, if you die within three years of transferring the policy into the trust, the transfer is presumed invalid by the IRS (this presumption can be overcome, however it is much simpler with a new policy), and the insurance would be included in your Federal taxable estate. Also, depending on the replacement value of your existing policies (what it would cost to buy them now), you probably would have to pay a gift tax. If you want to transfer existing policies to your trust, you should talk with an insurance professional about options on creating a new insurance policy from an existing policy.

Also, the irrevocable trust is a separate legal entity. That means that unlike your living trust, the irrevocable trust must file its own tax return, using its own tax identification number. The identification number will be applied for on the SS-4 tax identification application form that will be filled out by me and ready for the trustee to sign and mail to the IRS in the envelope that will be provided. The return is Form 1041 for estates and trusts which the IRS will automatically send to the trustee each year. The return is very simple to fill out because there will be no taxable income or deductions for the trust; all zeros (it should not take more than a few minutes to fill out each year). That is because life insurance does not create any type of income tax liability.

To get the tax benefits, you cannot be the trustee of your insurance trust. So you will need to name someone else as your trustee. Most people choose an adult child (who can also be a beneficiary), or a trusted relative or friend as the trustee. If this is not appropriate, you can choose a corporate trustee, such as a bank.

Even though you can't be the trustee, you still have some control over your trust. The trustee you select must follow the instructions you put in your trust. And, remember, your trust owns the insurance policy—that is very different from giving the ownership away to another person.

You can set one up at any time, but because the trust must be irrevocable, some people wait until they are in their 50's or 60's. By that time, family relationships have pretty much settled—and you know who you want to include (and exclude) as a beneficiary. Just make sure you don't wait too long—you could become uninsurable.

1. The trust is irrevocable, it cannot be changed or revoked.

2. Anything that you put into the trust cannot be used or controlled by you.

3. You may not be the trustee (however, a beneficiary can be trustee).

4. The trust must file its own (very simple) tax return.

5. The beneficiaries will have the right to take the gifts that you make to pay premiums for the insurance.

1. It can save your beneficiaries tens or hundreds of thousands of dollars in Federal estate taxes. In the example given above, over $153,000!

1. The trust is signed by you once it has been created.

2. The SS-4 is signed and mailed into the IRS.

3. A new (or existing-remember the "three year of death" rule) life insurance policy is put into the trust.

4. The trustee opens a checking account in the name of the trust using the trust tax I.D. number.

5. You make a gift (premium payment) to the trustee of the trust.

6. The trustee deposits the gift in the trust checking account.

7. The trustee sends out the notification letters to the beneficiaries (the trustee must also do this for him/herself if he/she is a beneficiary).

8. The beneficiaries return the letter declining the gift (or 30 days goes by).

9. The trustee pays the premium with a check from the trust checking account.

10. The trustee files the yearly tax return, Form 1041, supplied by the IRS.

11. When you pass away, the trustee follows the trust instructions to use the proceeds of the life insurance.

12. No estate taxes are due to the government.