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The high estate tax poses a dilemma for asset-rich yet cash-poor Americans. To pay the massive tax bill, heirs may have to liquidate their real estate or private businesses.
But there’s an alternative to fire sales: the wealthy can use life insurance to pay the bill through a clever loophole.
Instead of directly owning a life insurance policy, the wealthy will purchase a policy and place it into an irrevocable life insurance trust (ILIT). The ILIT then collects the death benefit, pays the tax bill, and distributes any remaining funds according to the insured’s wishes.
In this way, any payout is shielded from estate taxes, even if the insured’s assets and death benefits exceed the exemption amount. (Currently, the federal estate tax rate of 40% applies to assets over 13.61 million USD.)
For an ultra-high-net-worth individual with a 10 million USD life insurance policy, using an ILIT could result in tax savings of 4 million USD.
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Through life insurance trusts, the ultra-wealthy can bypass estate taxes for their heirs. Photo: Pexels. |
“It’s an easy solution. It doesn’t take away access to anything for anybody,” said Robert Strauss, a partner at the law firm Weinstock Manion.
The insured can choose anyone as a beneficiary, such as a business partner or friend. While less common today, ILITs have been used to provide for unmarried partners or extramarital relationships.
Like other types of trusts, the insured can choose a trustee to manage how the money is distributed to the beneficiaries. For example, a family member may receive a distribution to pay for college tuition instead of a sports car.
Dan Griffith, director of asset strategy at Huntington Bank, added that if the insured wants to ensure their heirs are protected from creditors or divorcing spouses, they can use an ILIT for double protection. Although laws vary by state, both trust and life insurance enjoy strong legal protection.
“Even if, for some reason, a creditor could get access to the trust assets, the insurance contract may still be protected by state law,” Griffith said.
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