Most life insurance should be held in an insurance trust to keep it out of your taxable estate, protect the proceeds from creditors and divorce, provide management, save state income taxes, and more. With all these tremendous benefits, your trustees should be paying careful attention to monitoring and administering your trust. But few do. Here is a check list of steps to help you through the muck. You need to address each item for each trust you have.
Step 1: Be sure everyone has signed the trust: you as grantor (person forming and funding the trust) and the trustees. Too often you, and perhaps one trustee, sign at the lawyer’s office, while the other trustee doesn't sign (or fails to get his signature witnessed, or notarized).
Step 2: The trustees must complete, and sign (in their capacity as trustees) all applications, and forms from your insurance company. The application must list the correct name of the trust and trustees.
Step 3: Obtain a tax identification number (TIN) for the trust. You can get this online at www.irs.gov/businesses/listssmall/article/0,,id=98230,00.html. Write the TIN on the front page of the trust. Everyone you work with will need it (bank, insurance company, etc.).
Step 4: Your trustees should take a signed copy of your trust (with the TIN on it) to a bank and open a trust bank account. Deposit a nominal amount to get the account started (usually an amount is listed on the last page or schedule of the trust - deposit that amount). It should be a check written by you (the grantor) to the exact name of the trust. If a premium is due soon, you should write a separate check for an amount sufficient to cover those costs. The best account is usually a non-interest bearing, free checking account. No interest means no tax problems. No charges means fewer headaches.
Step 5: Be sure the insurance applied for is issued in the name of the trust. If existing insurance is being transferred to the trust, contact your insurance agent, and request a written estimate of the value of the insurance policies being transferred, the balance of any loans outstanding, the amount of the policy which can be borrowed against, and the documents to complete the transfer. The value of the policies is important to avoid any gift tax cost on making the transfer. This is usually complicated, and should be worked out in a meeting with your estate planner, or CPA, and your insurance agent. You have to survive 3 years after the transfer to get the insurance out of your estate, so complete the transfer to get the clock ticking.
Step 6: Your insurance trust probably includes a demand or Crummey power to qualify your gifts to the trust for the annual $12,000 gift tax exclusion. Each time a gift is received by the Trust, the trustees should send the beneficiaries a formal notice of the amount of gifts made in total and for the credit of that beneficiary. The beneficiaries must sign and return these notices for the trustee to hold in the trust files. This is like how the commercials on TV caution you not to try it at home. Have your estate planner, CPA, or insurance agent walk you through the first ones. The calculations are not obvious and the entire concept defies logic. Even if the estate tax is repealed, or won't affect you, you need to continue these procedures if they are in your trust.
Step 7: Your trustees should pay for the insurance premiums using checks on the trust bank account made payable to the insurance company. Note the policy number and trust TIN on the check. If you have more than one trustee, ask the lawyer who drafted the trust if all trustees need to sign all checks and deposits. Some trusts permit one trustee to handle limited administrative tasks alone, but many don't.
Step 8: Ask your CPA if you need to file a tax return. Many insurance trusts are "grantor trusts," meaning the income is reported on your return, but the trust might still file its own Form 1041 indicating income.
Step 9: Meet annually with at least one of your advisers to be sure that you are properly caring for your trust. Your adviser should review trust bank accounts, to be sure they are set up properly, insurance policies, to be sure they are in the trust, and Crummey notices, to be sure they are done correctly. They should also monitor your plan to evaluate the appropriateness of the coverage and plan, periodically get a review of the insurance policy (in force illustration) and trust administration issues, etc.
Failing to follow up on the above, or not monitoring your trust, could jeopardize any or all of the significant benefits.
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