Wills and Trusts

Wyatt, Tarrant & Combs, LLP

The Irrevocable Life Insurance Trust

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This article is not for everyone but, if you are affluent, it is most likely that your accountant, financial planner or banker may have suggested that you consider a life insurance trust as a part of your estate plan.

A life insurance trust is a combination of two of the most commonly used estate planning tools:  life insurance and an irrevocable trust.  While many acquire life insurance for the purpose of building an estate or providing dollars to assure the support of our family, for others life insurance is acquired for an entirely different purpose:  to provide cash to pay death taxes.

A Review of Death Taxes

Before we look at the Life Insurance Trust, let’s review death taxes.  Everything you own is taxed at your death.  Some portion of this tax is payable to the federal government in the form of an estate tax.  A smaller, but equally significant, portion may be paid to the state in which you live in the form of an inheritance tax.  The rules regarding death taxes are complicated. The general rule is that transfers between citizen spouses will not produce any death tax liability.  However, at the death of the surviving spouse, when the estate passes to the children, all assets of the estate are taxed to the extent that they exceed the available exemptions.  The tax rate can be 40 cents on the dollar.

Under current law, you can pass $5 million* to children w/out federal estate tax.  Once an estate exceeds $5 million, federal estate taxes are imposed at 40%.  In big estates this tax can be quite significant, even with proper planning.

Using Life Insurance to Pay Taxes

Life insurance is frequently utilized by affluent clients to provide needed cash liquidity at death in order to pay death taxes.  Death taxes are payable nine months following death.  The availability of life insurance at death eliminates the necessity to sell property which the family would prefer not to sell either because of its unique value to the family or because market conditions are not conducive to a sale.

The biggest problem with purchasing life insurance to pay death taxes is that the acquisition of the life insurance adds more assets to the estate.  Thus, if you acquire an additional $1 million to provide liquidity to pay death taxes, you have added $1 million to the value of the estate and increased the tax liability by another $400,000.  Only $600,000 is left for use in paying death taxes.

The Irrevocable Trust

By coupling life insurance with an irrevocable trust, you create an entirely new estate planning tool whereby life insurance is not part of your estate and is not taxed at your death.  Thus, if you own a $1 million life insurance policy in an irrevocable life insurance trust, the entire $1 million passes death tax free and is available to the beneficiaries.

A life insurance trust is an Irrevocable Trust established by a Grantor (the insured) with a Trustee (trusted family member, friend, or trust company) for the benefit of certain beneficiaries (spouse and/or children).  The trust is the owner and beneficiary of life insurance on your life.

At least annually, you make a gift of money to the trust.  The Trustee takes the gift and, after complying with IRS rules, uses the gifted money to pay the premium on the life insurance policy.  The policy cash values or death proceeds may be used by the Trustee to provide for your spouse and/or children.

If the trust is properly structured and if you follow the rules, both the gifts to the trust (premiums paid) and the life insurance proceeds can be excluded from both your estate and your spouse’s estate at death.  In some cases, the proceeds can also be excluded from the estates of your children as well at their later death.  What is important is that tax free cash is available to pay death taxes.  Many are surprised to learn that they can control the use and disposition of life insurance proceeds on their lives through a life insurance trust in any reasonable way that they desire.  The proceeds can be invested and distributed as you elect rather than being distributed as a lump sum at death.

But life insurance trusts also have serious drawbacks and consequences that may make them unsuitable for many clients.  First of all, they are irrevocable.  Once a life insurance trust is established, it cannot be altered, amended or terminated by the insured.  In addition, the cash values in the policy are not available to the insured, only the beneficiaries.

Even though a life insurance trust is irrevocable, if you stop making gifts to the trust and stop making premium payments, the policy may lapse and the trust will effectively go away.

Some are too young to lock up a policy of life insurance within an irrevocable trust.  Another’s family circumstances are unstable and contain too many unanswered questions to create a trust which may last for 40 or 50 years without being changed.

Some wait too late to consider an insurance trust.  Using new life insurance coverage requires that you be insurable.  Moving existing life insurance into a trust requires that you live at last three years to achieve tax benefits.

In establishing a life insurance trust, the insured must not only give up the power to control the insurance, but the insured must give up all rights to the policy, such as rights to cash values, policy dividends and the right to designate or change beneficiaries.

The inflexibility of a life insurance trust requires careful planning by the insured and requires a detailed evaluation by the client of the future needs and requirements of the client’s family.  Finally, Congress or the courts could retroactively change the rules and tax the insurance no matter how you structure it.  Even if the rules are changed, the tax you should pay is no more than what you would have paid had you done nothing.


The advantages of utilizing a life insurance trust to own your life insurance may be too substantial to pass up.  Sheltering the life insurance policy proceeds from federal death tax can save 40 cents on the dollar.

Premium dollars are converted to tax free gifts to the children.  Lifetime gift tax exclusions are used rather than lost and the gifts made today in the form of life insurance premiums are converted to a tax free inheritance at your death.


Savings such as those outlined above do not come easily.  Life insurance trusts are complicated tax sensitive documents.  The IRS has vigorously reviewed the use of life insurance trusts for decades.  However, the law, created by Congress and the courts and not by the IRS, establishes definitive guidelines allowing for the establishment of a life insurance trust which can meet the needs and goals of most families, assure the protection of the spouse and/or children and provide dollars to avoid the necessity of a forced sale of assets to pay taxes at death.

In estates exceeding $5 million where life insurance is an estate asset, an irrevocable life insurance trust should be considered as an estate planning alternative.  In most large estates, it is an alternative which cannot be ignored and should be implemented.

* The $5 million exemption is indexed for inflation.  For 2014, the exemption is $5.34 million.  A $5 million exemption is used herein for convenience.

A. Stephen McDaniel
Memphis, Tennessee


Leave a reply. Please note that although this blog may be helpful in informing clients and others who have an interest in information privacy and security, it is not intended to be legal advice. The information on this blog also should not be relied upon to form an attorney-client relationship.

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