If an existing insurance policy is transferred to a trust (or TOLI), the proceeds will be included in the insured’s estate if the insured dies within 3 years of transfer date (which is the same result if there was no TOLI to begin with). Because this risk is unavoidable in many instances, a life insurance trust should specify what will occur if the insured fails to survive the period.
As it pertains to married couples, if the TOLI would otherwise be included in the insured’s estate, the trust document should state that the trust will be distributed in a manner qualifying for the marital deduction. If the trust document doesn’t have such a directive, and there is no will or revocable (living) trust providing a different method to pay the estate tax, the TOLI will be on the hook.
This being said, it is important that your revocable (living) trust or will does not ambiguously state that your death taxes should be paid from the residue of your estate. Doing so may be insufficient to override IRC §2206, which requires a provision in your will or revocable trust to prevent proceeds from a life insurance policy from paying portions of your taxable estate (which, in theory, could result in an incident of ownership, thus making all the insurance proceeds subject to your estate).
