Irrevocable Trusts and Life Insurance Trusts

Scottsdale Estate planning lawyersWhen formulating your estate plan, there are many issues that need to be considered. One possible tool in the planning process is an irrevocable trust. An irrevocable trust generally cannot be modified or terminated without the consent of the beneficiaries. There are several reasons why an irrevocable trust may be a helpful tool. These include lowering estate taxes, providing a pool of liquidity to pay estate taxes, protecting a large sum of money left to a minor or to an adult who may not handle the funds responsibly, or to create asset protection.

At Colby&Thornes, our Scottsdale estate planning attorneys know the benefit and the potential pitfalls of an irrevocable trust. They can advise you whether it will assist in your estate plan, and make sure that it is properly established and administered. Contact us to schedule an appointment.

What is an Irrevocable Trust?

An irrevocable trust, generally, cannot be rescinded or modified by the settlor/grantor after it is created. Irrevocable trusts can hold any type of assets, including a life insurance policy paid on the death of the settlor/grantor, called an ILIT.  Generally, the settlor/grantor gives up all rights of control and management of any ILIT or other irrevocable trust when created.   But the settlor/grantor does decide who the beneficiaries will be, and the terms under which they will receive the proceeds of the life insurance policy or any other assets owned by the ILIT or other irrevocable trust.

Assets transferred by the settlor/grantor to an ILIT or other irrevocable trust are subject to federal gift tax laws, and if the value of the assets transferred by the settlor/grantor to the ILIT or irrevocable trust exceeds the annual exclusion amount for any tax year (based on a published IRS table), a Form 709 gift tax return must be filed.

Beginning the Process

When we sit down and discuss your goals, a decision will be made as to whether an ILIT makes sense in your situation. If so, several questions must be addressed, including:

  • Who will be the beneficiaries of the irrevocable trust?
  • What will be the terms of the receipt of the funds by the beneficiaries?
  • Who will serve as trustee(s)?
  • Will the trust hold an existing life insurance policy owned by you, or will it purchase a new policy?
  • How will the trust be funded, and how will the premiums on the life insurance policy be paid?
  • If the irrevocable trust does not hold a life insurance policy, what type of assets are gifting into it?
  • Is the settlor/grantor complying with federal gift tax laws when transferring property or life insurance premiums to the ILIT or irrevocable trust?

These questions must be resolved in a manner that achieves your goals, while avoiding the creation of additional problems, including tax liability.

Advantages of an ILIT or an Irrevocable Trust

The primary benefit of an irrevocable trust is to provide funds for family and loved ones, without having the proceeds included in your estate for tax purposes.  This will apply to life insurance death benefits of an ILIT or to other assets gifted by the settlor/grantor to any other irrevocable trust holding assets other than life insurance. You can dictate how and under what circumstances the funds will be distributed. The funds can replace earnings for family members, provide for the education of children and/or grandchildren, cover the costs of final expenses, and provide liquidity to pay taxes. And because the trust owns the policy, and not the beneficiaries, an ILIT and other types of irrevocable trusts can provide a measure of asset protection from creditors of those beneficiaries.

Of course, in order to enjoy the benefits of an ILIT or other irrevocable trust, it must be properly designed, drafted and administered, and all gift tax laws must be followed.

Potential Pitfalls of an Irrevocable Trust

There are several potential pitfalls that could sabotage the goals you are seeking to reach when you go about setting up an irrevocable trust or ILIT. They include:

  • Indicia of ownership. If the settlor/grantor retains control over the trust, or acts as trustee, the IRS will consider the proceeds of the policy or other assets owned by the irrevocable trust to be included in the estate of the settlor/grantor for tax purposes. This issue can be avoided by having the irrevocable trust properly designed, drafted and administered by competent professionals.
  • If you die within three years of transferring assets to an irrevocable trust, the IRS may consider the proceeds as part of your estate for estate tax purposes. If, as the result of age or illness of the settlor/grantor, the three-year window must be understood and its risks taken into account before any such transaction is undertaken.
  • Gift Taxes. The settlor/grantor must comply with all federal gift tax laws relating to the gifting of money or property to an irrevocable trust, and should consult with a competent professional on such matters before the transaction is commenced.

Scottsdale Trust Attorneys

At Colby&Thornes, we are knowledgeable and experienced estate planning attorneys. Contact us to find out how an irrevocable trust can make a difference in achieving your estate planning goals.

Colby & Thornes is an Arizona Professional Limited Liability Company. The members of the company are David H. Colby and Megan A. Thornes. This website is intended to provide information about our practice and the legal services we offer. It is not intended to create, nor does it create, an attorney-client relationship. The website is informational only, and should not be relied upon as a substitute for legal advice from a licensed attorney at law.

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Colby & Thornes PLLC
Gainey Ranch Financial Center
7373 E. Doubletree Ranch Rd. Ste. 225 Scottsdale, Arizona 85258
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