Life insurance trusts have long been hailed as a smart way to provide financial protection for loved ones while simultaneously avoiding any adverse estate tax consequences—but the question that most often arises today in the context of life insurance trust is, do I really need it?
The 2017 tax reform law doubled the estate tax exemption, to $11.4 million per person ($22.8 million per married couple) in 2019, meaning that, for all but the fortunate few clients, the estate tax itself may seem irrelevant. For some clients, dismantling existing life insurance trusts may be the smartest move—but not without considering both the repercussions of that approach and carefully planning for any continuing life insurance needs, where a tax-free replacement strategy may be key to safeguarding future financial protection.
Look Before You Leap: Reasons to Keep the Trust Intact
First and foremost, one reason that clients may wish to keep their life insurance trusts intact is the possibility that the exemption level will change going forward—in fact, it's already scheduled to revert back to between $5 million and $6 million in 2026. The tax law is never permanent, even if the tax code says it is, so clients should remember that a change in the political winds could mean that the exemption will decrease and/or the estate tax rate could increase.
For other clients, state-level estate and inheritance taxes could be a consideration in favor of keeping the life insurance trust intact. States that do have estate and inheritance taxes have overwhelmingly chosen to keep their transfer tax exemptions at pre-reform levels, meaning that if state taxes were an issue for the client pre-reform, they continue to present the same issues now.
Clients with liability concerns, whether relating to a business, malpractice possibility or otherwise, might want to consider the asset protection value of the life insurance trust before choosing to dismantle it.
Dismantling an Existing Life Insurance Trust
If the client chooses to dismantle the trust, that process is actually fairly straightforward. The client could choose to give the policy to his or her spouse, and if there are no other assets held in the trust, that would be the end of the story—with no assets, the trust would essentially be dismantled.
In some cases, the client should obtain the consent of any remainder beneficiaries to the trust—for example, adult children. Often, obtaining this consent is not a problem. If the client is concerned about future issues, he or she could execute a non-judicial settlement agreement that would essentially provide a formal agreement to dismantle the trust and distribute the policy.
