146 / Can a life insurance trust result in income tax savings for the grantor?

Income tax savings can be achieved by the creation of an unfunded life insurance trust. Additionally, a life insurance policy creates no currently taxable income regardless of whether it is placed in trust. Income tax savings can result only when income-producing property is placed in trust to fund the premium payments, and only if tax liability is shifted from the grantor to a lower bracket taxpayer – that is, to the trust or to a trust beneficiary.

A funded revocable trust will not result in income tax savings. If the trust is revocable, the income from the funding property will be taxed to the grantor. Even if the trust is irrevocable, however, there are other conditions that will cause the trust income to be taxed to the grantor.

Generally speaking, trust income is taxable to the grantor if the:

(1)     grantor or trustee, or both, can revoke the trust without the beneficiary’s consent;

(2)     trust income is, or in the discretion of the grantor or a non-adverse party, or both, may be (a) distributed to the grantor or the grantor’s spouse, (b) accumulated for future distribution to the grantor or the grantor’s spouse ( Q 148), or (c) applied to pay premiums on insurance on the life of the grantor or the grantor’s spouse ( Q 147);

(3)     income is or may be used for the support of the grantor’s spouse or is actually used for the support of a person whom the grantor is legally obligated to support, or is or may be applied in discharge of any other obligation of the grantor;

(4)     grantor retains certain administrative powers or the power to control beneficial enjoyment of trust principal or income; or

(5)     value of a reversionary interest, at the inception of the trust, exceeds 5 percent of the value of the trust.¹