Irrevocable Life Insurance Trusts are established to hold life insurance products. In many circumstances, properly drafted life insurance trusts can be funded in such a way that allows the person setting up the trust to move funds to the trust enabling it to both purchase insurance initially, as well as pay the annual premiums on such insurance. This can usually be accomplished without using any of the settlor’s lifetime gift tax credit (resulting in no tax being generated due to the transfers).
At the death of the settlor, the insurance proceeds are distributed directly into the trust. Since the trust is a separate taxpayer for tax purposes, this often results in no inclusion in the taxable estate of the settlor. The funds in the trust can then be used to purchase property from the estate if the estate needed cash to pay taxes or other expenses. Finally, the insurance proceeds can be distributed to the individuals and entities of the settlor’s choice (evidenced in the trust document itself) replacing any value that could not come from the estate because of tax and expense payments by the estate.
The Survivorship Standby Trust can be used in situations where there is:
1. a desire to retain access to the cash value of the life insurance policy;
2. there is no need for a payout of the policy until the death of the surviving spouse (i.e., there is no need for cash upon the death of the first spouse to die);
3. a desire to have the option to add liquidity to the estate of the second spouse to die to pay estate expenses and taxes; and
4. a desire to pass the policy proceeds to family, friends, charity or other recipients without having the policy payout value included in the taxable estate of either spouse.
The spouse that is statistically more likely to be the first to die (typically the husband) purchases a second to die policy directly. During life, this spouse pays the insurance premiums directly. Therefore, these premiums do not need to utilize the spouse’s annual gift tax exclusion and will not count against that spouse’s lifetime estate and gift tax credit. Additionally, during life, the owner of the policy has access to the cash value of the policy. At the death of the owner, a Survivorship Standby Trust is established by Will or other testamentary document. Because the policy does not pay out until the death of the second spouse, there is no estate tax inclusion of the policy payout amount. Upon the death of the policy owner, however, the cash value of the policy will be included in the taxable estate. The ownership of the policy is then moved into the Survivorship Standby Trust, which functions from that point forward in much the same way as the Irrevocable Life Insurance Trust. If the policy premiums are not paid up, the surviving spouse may contribute value to the Trust so that the trust may continue to pay the premiums.
At the death of the surviving spouse (the second to die), the insurance proceeds are paid to the Trust. The Trust can then purchase assets from the estate of the second to die (or may be able to make loans to the estate) to provide liquidity to the estate so that the estate can pay expenses or taxes. The Trust will ultimately distribute the insurance proceeds to the beneficiaries.
