Tip to Minimize Minnesota Estate Tax: The Irrevocable Life Insurance Trust (ILIT).
Irrevocable Life Insurance Trust (ILIT)
Here in Minnesota, life insurance proceeds are subject to the estate tax if they and your estate are more than $1 million. A handy tool to avoid estate taxes on your life insurance proceeds is an irrevocable life insurance trust, often referred to by the acronym ILIT. An ILIT is an advanced estate planning tool that can minimize or avoid estate taxes while helping you provide for your family at your passing.
Many people purchase life insurance to provide money to help their family, particularly minor children, after their passing. However, most are not aware that their family may not receive all of the benefits after they die. As of the time of this article, if your total estate is worth more than $1 million dollars, any value over that is taxable for estate tax purposes in the state of Minnesota. Any estate worth more than $5.25 million is taxable at the federal level for estate tax. What many people also do not know is that the proceeds of their life insurance policies are included in their estates to determine whether or not they have a taxable estate. So, for example, if you and your spouse each have $1 million dollar life insurance policies - to make sure there is money for each other and your kids in the event of your passing - you have a taxable estate in Minnesota even before you add in the value of your home, retirement, investments and other assets.
How ILITs Work to Minimize Estate Taxes
If you own your life insurance policy, the IRS considers it part of your estate for estate tax purposes. However, if you create an ILIT, and have the trust as both the owner and beneficiary, the proceeds of the policy will not be included in your estate for estate tax purposes. You can direct that the trustee of the trust use the proceeds to provide for your spouse and/or your children. By doing this, you can make the proceeds available to help your spouse and your children in the event of your passing, while keeping the proceeds out of your estate for estate tax purposes.
You Must Give Up Control
In order to meet Internal Revenue Service “IRS” requirements, your ILIT must purchase the policy and be listed as the beneficiary. You must not have the right to change the beneficiary or borrow from or against the policy. You must also not act as the trustee of the ILIT. If you fail to do any of the above, the proceeds can be included in your estate for estate tax purposes.
You Can Transfer an Existing Policy Into an ILIT
If you already have an existing life insurance policy or policies, you can still create an ILIT to minimize or avoid estate taxes on the proceeds, but you must meet IRS requirements. Under current IRS rules, you can transfer an existing policy into an ILIT. However, if you pass away within three years of the transfer, the proceeds of the policy will still be included in your taxable estate.
Paying the Premiums
Even though your ILIT owns the policy, you can still pay the premiums. You can transfer funds to your trustee on a regular basis to pay the premiums. Under current law, you can transfer $14,000 per year, per person, without incurring a gift tax. The funds can be used by your trustee to pay the premiums. If you transfer more than $14,000 per year, a taxable gift has occurred. If you transfer less than that amount, there are no tax implications.
The Proceeds Can Be Used to Help Your Spouse and Children
After your passing, the trustee collects the life insurance proceeds and then manages them as you instructed when you first set up the ILIT. That means the funds can be used as you direct for the health, support, maintenance, education and other needs of your surviving spouse and children.
The Proceeds Can Also Be Used to Pay for Estate Taxes
If you have a particularly large estate, you can also use an ILIT to provide the liquidity your family may need to pay estate taxes upon your passing. Many larger estates may include a business, real estate or other assets that you either may not want to sell or may be difficult to sell quickly. In the absence of the necessary liquidity, selling the assets may otherwise be necessary to pay estate taxes. By using an ILIT, the proceeds of your policy can be kept outside of your estate for estate tax purposes yet be made available to pay any other estate taxes without the necessity of selling assets.
Consider a Dynasty Trust
An ILIT can also be structured as a dynasty trust providing even more planning options to take care of your children and grandchildren.
If you have further questions about irrevocable life insurance trusts or want to discuss how an ILIT may help you and your family, call us today at (763) 420-5087.