Return to HomePage
To Contact us: email
Return to Estate Planning Directory
LIFE INSURANCE / CHARITABLE
This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal adviser.
There are normally three reasons to have life insurance:
- To care for those whom you would ordinarily support, after your death;
- To pay death taxes; and
- To convert taxable assets to tax free assets.
TAXATION OF LIFE INSURANCE PROCEEDS
Life insurance proceeds are usually subject to death taxes, depending on the form of
ownership. Therefore, proper ownership of a life insurance policy is very important.
If you own insurance (or even retain the right to change the beneficiary of the policy) on
your own life, the death proceeds are part of your taxable estate. To put it simply, if you
are single, and have a $600,000 policy, and $100,000 of other assets, at your death, your
estate will owe $37,000 in taxes. Tax is imposed on a total of $700,000; $600,000 is tax
free; the balance is taxed at 37%.
Tax Free Insurance: If the insured does not owns the policy, there are no taxes at his
Support of Spouse
If a married couple has insurance to support the widow at the untimely death of the high
wage earner husband, there is no tax at his death; anything going to a surviving spouse is
Support of Children
If the primary intent is to care for children rather than the spouse, tax considerations
become more important. Since Life Insurance is usually subject to death taxes, tax
protection is vital, or the insurance will cause additional taxation.
Payment of Death Taxes
A single person owns one asset: a home worth $750,000. He wants to leave it to his
children. He figures that with an estate of $750,000, he needs a policy for $55,000 to pay
the death taxes. However, his death taxes are based on his total assets, which usually
includes insurance. Because the insurance is subject to death taxes, on his $805,000
estate death taxes are $76,000. His kids come up short.
Imposition of death tax on insurance causes a vicious circle; buying more insurance
causes an increase in both the taxable estate and the taxes. He needs almost $100,000
of insurance to pay tax on the house and the insurance.
Proper Ownership Techniques
There are several methods of avoiding taxation:
Young beneficiaries pose a problem. A young child cannot (or should not) be outright
beneficiary of a life insurance policy.
- The beneficiary may own the policy.
- A trusted friend may own the policy.
- A Life Insurance Trust may be used.
1 - Adult Beneficiaries as Owners: Of course, if your children are mature and stable,
they may be the owners personally, paying premiums with money you give them.
However, a Trust could provide them with asset protection.
2 - Give "Uncle Bob" the policy, and money every year with which Bob pays the
premiums. Your child is beneficiary. Bob is subject to gift tax on the proceeds, when
you die. Also, there are risks:
3 - A better method is a Life Insurance Trust.
- Uncle Bob cashes in the policy, or he pockets the money you give him to pay the
premiums, and the policy lapses. Actually, this may be immoral of Uncle Bob, but not
illegal - it is his policy!
- Uncle Bob changes the beneficiary. It's his policy, he can do what he wants.
- Uncle Bob gets sued by his own creditor who takes away the policy. Since the policy
belongs to Bob, it is subject to attachment by his creditors.
- Uncle Bob gets divorced, and his wife gets half the policy.
- Uncle Bob dies, his wife inherits the policy and she changes the beneficiary.
When a Life Insurance Trust is formed, you name a person to manage it. Normally, that
will not be you or your spouse.
If you have an existing life insurance policy, you can put that into the Trust, or you can
have the Trust buy a new policy. The annual premiums are paid from funds which you
A Life Insurance Trust is irrevocable. If you form a Trust for the benefit of all of your
children equally, and later would like to `disinherit' one child, you cannot change the Trust.
All you can do is to stop making gifts to the Trust, leaving it with an insurance policy
which lapses due to nonpayment of premiums.
Of course, the major reason to have a Life Insurance Trust is to avoid the risk of ownership
by another person, and to ensure that the beneficiaries do not receive substantial assets
until they are mature enough to handle them.
A Charitable Remainder Trust [CRT] allows the owner to contribute property to a self-
controlled Trust. The owner (and his spouse) have the right to take out a predetermined
amount of income (set by them) from the Trust during their lifetimes. After the death of
both owners, the assets go to their favorite charity.
During the lifetimes of the owners, there are taxes only on their annual withdrawals. Since
everything goes to charity when the owner and his spouse have died, the Trust is tax
The basic plan is as follows:
- You have a low cost asset you want to sell, but the tax will be very high. You
contribute the asset to a CRT. You manage the Trust and sell assets tax free when you
- You set the amount of income you want, with a minimum of 5% per year.
- You pay tax only on the money taken out of the Trust each year - no tax is paid on any
profit, until it is withdrawn from the Trust.
As with a Living Trust, you are the sole manager. However, you cannot change any terms
of the Charitable Trust, other than to appoint a different charity to take the assets at your
In any year contributions are made to the CRT, you get an income tax charitable
deduction, based on your life expectancy and income rate. The charity will not receive the
gift until your death. The older you are, the shorter your life expectancy, and the bigger
your deduction is.
A CRT will allow the tax free sale of an illiquid asset with a poor cash flow. With no tax to
pay, all of the sales proceeds can be re-invested, generating higher after tax annual cash
The drawback to Charitable Trust is that it cannot be changed even in a dire emergency.
Since the charity gets the Trust balance at your death, many people also use an
Insurance Trust as a "wealth replacement" vehicle to leave assets tax free to their
Return to Estate Planning Directory