A "life insurance trust," or LIT, is an arrangement whereby an individual transfers life insurance policies or funds to purchase life insurance policies and subsequently transfers additional funds to the trustee of the trust to pay premiums on life insurance held by the trust. Upon the death of the individual, the life insurance proceeds are administered and distributed by the trustee pursuant to the terms of the trust as established by the decedent.

Some of the benefits of a life insurance trust are:

Transfers of up to $10,000 per beneficiary may be made each year in such a manner as to qualify for the annual gift tax exclusion.

Insurance proceeds are not subject to estate tax on the death of the individual, unless the policy was transferred to the trust within three years of the death of the individual.

Other assets of the individual may "pour over" to the life insurance trust upon the death of the individual, providing for uniform management and disposition of the individual's estate.

If you assign all ownership of your life insurance policy to an individual or an irrevocable trust at least three years before your death, the death benefit is not included in your estate. Typically, your spouse will receive income, and in some instances, distributions of principal, from the irrevocable trust for the rest of his or her life. At your spouse's death, the assets in the trust pass to the next generation tax free.

Many people establish irrevocable life insurance trusts to provide funds for paying estate taxes so that existing assets, particularly real estate and business assets, do not have to be liquidated. There are many advantages to establishing an irrevocable life insurance trust.

Some of the disadvantages of an irrevocable life insurance trust are:

The trust terms and beneficiaries cannot be changed once the trust agreement is executed.

Your spouse will not have direct access to more than a small portion of the funds held in the trust.

The policy proceeds will be taxed in the grantor's estate if he or she dies within three years following the date on which an existing policy is transferred to the trust.

A "charitable remainder trust," or CRT, is an arrangement whereby an individual transfers property into a trust and generally receives a payout from the trust for the rest of his or her life (and, if desired, the life of his or her spouse). Upon the individual's death, the property in the trust passes to a charity (or charities) selected by the individual.

Some of the benefits of a charitable remainder trust are:

There is usually no gift tax on the transfer to the trust.

A substantial current income tax deduction is available for the value of the charity's remainder interest (determined actuarialy based on the individual's age and the payout rate chosen).

There is no income tax to the trust on income received.

There is no income tax to the trust on the sale of appreciated assets.

Distributions from the trust may be taxed at capital gain rates.

There is no estate tax on the value of the property in the trust at the time of the individual's death.

The charitable remainder trust/life insurance trust combination offers maximum benefits to individuals who:

Own highly appreciated assets.

Are insurable.

Need increased cash flow.

Desire to benefit charity.

Want to increase the inheritance (net of tax) which will pass to their heirs.

A charitable remainder trust can be used to "unlock" the appreciation in assets without incurring a large up-front tax, while providing a steady stream of income to the individual. A portion of this cash can be used to fund life insurance owned by an irrevocable trust, the proceeds of which "replace" the property transferred to the charitable remainder trust. Reinvestment of the proceeds from selling the property increases cash flow while removal of the appreciated property from the individual's estate reduces estate tax. The individual has more income during life and his or her heirs receive a larger inheritance at the individual's death.

EXAMPLE of CRT/LIT Combination

• Individual owns securities with a tax basis of $75,000 and a fair market value of $500,000, which produce monthly income of $750

• Individual transfers the securities to a charitable remainder trust (CRT)

• The CRT sells the securities without incurring a tax on the realized gain of $425,000

• The CRT re-invests the proceeds in other securities

• The CRT pays to the individual a specified amount each month of $4,000 (equal to 9.6% of $500,000 gift, divided by twelve months)

• The payout received by the individual is taxable, but is typically sheltered for several years by carryover of the tax deduction generated by the gift to the CRT

• $1,000 of the monthly payout is used to fund insurance on the individual's life owned by an irrevocable trust

• Upon the individual's death, the proceeds from the insurance trust of $1 million are paid to the individual's family, thereby "replacing" the wealth they would have received had the individual retained the appreciated securities

• The remaining principal in the CRT is paid to charity

©2000 by Gomel & Davis, LLP. All rights reserved.

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