Years of working and putting away money into your IRA can be a blessing during retirement. For many retirees it represents a significant source of income, an emergency fund, and an asset to pass to their heirs. However, for those whose IRAs have grown large enough to trigger federal estate taxes, comes the burden of how to plan for what their beneficiaries will face.
(Note: Taxes on an IRA could be as high as 35% to income tax and 49% to estate tax with an IRD deduction to heirs offsetting the estate tax.)
Estate taxes are payable nine months after your death. And without liquid assets immediately available, your heirs will be forced to sell your IRA and lose up to 49% of your hard-earned dollars to the IRS. An irrevocable life insurance trust will create those needed dollars.
Withdraws could be made from your IRA each year, given to the beneficiaries of the trust, and used by the trustee to buy the life insurance. The irrevocable life insurance trust would then own the policy on your life. When you die, the death benefit is paid to the trust, kept out of your estate, and can be used to pay the estate taxes.
You could also authorize your trustee to use the death benefit to buy illiquid assets, like your home or business, from your estate. This would give your heirs the cash to pay the estate taxes without a forced liquidation.
You’ll have broad ability to direct the trustee in the management and distribution of the policy’s proceeds. But to keep the benefits out of your estate, you cannot have any incidents of ownership in the policy. Although you can get money from the trust if you need it and even have the beneficiaries determined based on their actions (i.e. they collect only if they finish college).
If you don’t have a taxable estate, a life insurance trust may have other uses. You may want to put life insurance in a trust to protect and control assets if the beneficiary is a minor or has difficulty managing money. Or perhaps you want to influence their behavior with cash (We Americans do believe that money talks, and you can make yours do so even after you’re gone).
Maybe you plan to provide for your current spouse. But you also want to make sure that your children from a previous marriage get something without increasing the value of your estate and making it taxable. This could be accomplished by naming your spouse the beneficiary of your IRA and your children the beneficiaries of the trust.
For an analysis of how the current estate tax law might deplete your IRAs and how an irrevocable life insurance trust may ease that hardship, return the enclosed coupon.