When my wife and I (both mid-30’s) had our wills drawn up a few years ago, our lawyer suggested placing our life insurance into an irrevocable trust to bypass estate taxes. Our current net worth is a bit over a million dollars and we have policies of $2 million and $1 million. We’re fine for federal taxes, but we live in WA and here the exemption is only $2 million with no portability. If we were both to die and our estate and life insurance were combined, then some of what is being passed on to our kids would definitely be subject to estate tax. We’re also expecting our net worth to grow over the years.
For various reasons, we’re planning to re-do my $2 million policy in the near future and this would be a good time to put it into a trust.
My understanding is that the major downsides of a trust are lack of control and the initial set up cost. I have legal insurance through work which, I believe, would cover the cost. The upsides are keeping our assets safe from estate taxes. Is there anything we’re missing here? Is the lack of control that big an issue?
Maybe OP needs the policy if they are the sole income earner in the family and have many kids to provide for. It’s hard to say but when redoing a policy, automatically signing up for the same amount as before is generally not a slam dunk.
If your kids are grown since the time you initially took the first policy, maybe you don’t need quite as much. Maybe you’ve accumulated savings that lower your needs for life insurance. Or maybe you need more if your insurance needs are similar and inflation has eroded the income replacement capacity of the original policy.
Assuming the legal costs are not a factor, depending on the estate tax rate in WA, it actually may be worth the hassle to have the policies in the irrevocable trust.
If all the trust holds is your life insurance policies, the loss of effective control is not too bad as long as you have a good trustee who’s guaranteed to act wisely for the benefit of all beneficiaries equally. If you have a single kid, the trustee situation should be easy. They should probably be the trustee (or their guardian if not old enough). But if you have several kids covered and/or not a trustworthy trustee around, the situation is definitely more complicated than just having the life insurance policies directly paid to the beneficiaries.
Also, the loss of control is basically permanent (until you let the policies lapse at least). If circumstances change (say premature death of your favorite trustee with no clear replacement), you move to a state with no estate tax, estate tax laws in your state change, etc…, your options are give up on the policies (likely more expensive) or be stuck with subpar options.
So the estate tax savings may be worth it but that’s dependent on the specific family situation.
Thanks Shandril! You’re generally correct on the reason for the policy amounts. Only one kid at the moment, but another one on the way and maybe a third eventually. And my wife will likely never be able to match my current income even if she went back to work full time, let along likely future increases in my salary. So the goal is to provide some income replacement and pay for the house, daycare, and college. Might be a bit generous, but not by much.
Having done some more research, the trustee issue really does look like the biggest one. It’s not just dealing with the money should I pass away, but life insurance trusts also require regular notices, paying premiums, etc… This is probably something we don’t want to saddle a family member with given that there’s no real benefit unless we both pass away before the policies expire (since otherwise much of the money would be spent ). Banks look like they charge $1-2k/year to be the trustee, at which point the fees don’t really make sense. Practically speaking, I could double my life insurance coverage for the amount of money banks charge. That would more than pay for the estate tax (10-20% over the $2M exception).
Given the ongoing costs (money/time/effort) and the rather low likelihood that there would be any benefit (especially given all the changes you suggested could happen), we’re leaning against it at the moment. But we’ll chat with our lawyer anyway to see if he has anything we’ve overlooked.
That’d be a good reason that losing 10-20% in taxes may not be that big of a deal as well. Especially considering the restrictions and costs associated with the irrevocable trust.
As far as the family member trustee, it’s not quite as complicated.
The main scenario here is the death of both you and your spouse. Since you have setup a will, you’ve also designated a guardian for your non-adult kids. They would typically be the trustee and the amount of work for them would not be much more than the guardianship itself that they are already providing. Even in the case of a life insurance policy outside a trust, the guardian would still receive the money with fiduciary duty to use it for the benefit of the kids until they are adults so their handling of expenses for the kids would not be that different in both cases.
One difference is that the trust could specify more complex distribution schemes (say if you wanted to distribute some of the money in several payments over time) compared to life insurance policies outside a trust.