Separate Property – is any property that is not considered Community Property, and typically includes all of the following:

• all property owned by someone before marriage;
• all property acquired (after marriage) by gift, bequest (legacy; inheritance), devise (left by will), or descent (inheritance with no will); and
• the rents, issues, and profits of the property described in this section.

Community Property – except as otherwise provided by statute, all property, real or personal, wherever situated, or acquired by a married person during the marriage while residing in California is community property. Legally speaking, there is also a presumption that any property (personal or real) acquired during marriage is community property. Moreover, commingling (or mixing together) separate property funds can change (or transmute) the property to community property, unless there is some sort of agreement in place to give notice to your spouse that you do not intend to make a gift, and are able to trace the funds to your separate property.

Settlor/Grantor – is the person that creates the trust, and is also the person who donates the funds to the trust.

Insured – is the person insured under an insurance policy, and is also typically the person who wants to create an irrevocable life insurance trust (or trust owned life insurance).

Decedent – is the person that died.

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The main goal of a TOLI is to prevent the death benefit from being included in the insured’s taxable estate and, if they are married, their spouse’s taxable estate. In the event that the insured’s spouse is a noncitizen, a related goal is to avoid additional requirements needed to qualify a trust for the marital deduction by eliminating assets from the insured’s gross estate.

In funding the TOLI to pay policy premiums, it is often possible to avoid gift tax liability by taking advantage of the gift tax annual exclusion unless the available exclusions are being used for other transfers.

Another great advantage of a TOLI is that the trust can offer much more flexibility in terms of managing assets and eventually distributing an estate held in trust. In addition, the trust assets are entitled to a great deal of protection from unforeseen creditors.

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Opening a Trust Bank Account

As it pertains to TOLIs (or trust-owned life insurance), the trustee should be the one opening up the trust bank account. In order to open a trust bank account, the trustee will typically need to provide the bank with two forms of identification, the signed original TOLI (or trust) document, a list of the TOLI’s beneficiaries, and an tax-identification number. You can get a tax-identification number for free online through the IRS website.

Funding the TOLI

Generally, there are two ways to fund a TOLI: with small periodic gifts, or through a large deposit. Smaller periodic gifts are recommended in order to take advantage of gift tax exclusions, which renew each year. However, it is also possible to transfer assets to the TOLI that produce income, and allowing the trustee to make premium payments with that income.

TOLI L.C. can do all this work for you through its trustee services, or as a one-time matter by filing a request with the IRS for an employee-identification number and opening a trust bank account with your relevant documents.

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For example, an illustration showing a policy’s performance based on a 6 percent earning rate will provide numbers that relate to premiums paid, and accumulation of cash value that are only accurate if the insurance company achieve a 6 percent earning rate for that period (i.e. if the insurance company meets the projections that assumed in the illustration). Therefore, the policy illustrations are used more as a sales tactic because performance is never guaranteed. This is something to keep in mind when reviewing different types of policies, and even different insurance companies.

Thus, it is important to ask insurance agents to show various illustrations based on different projections (especially as it pertains to guaranteed maximum premiums and guaranteed minimum earning projections).

NOTE: Hiring someone with experience in assessing different types of policies from different insurance carriers so that they can present them to you objectively is ideal (although not always practical).

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Thus, the owner of variable life insurance can invest the policy’s cash value investments similar to a mutual fund, stocks, bonds, government securities, and more, and the cash value has more protection as it is not subject to claims by the insurer’s creditors.

The trade-off is (1) the policy owner carriers the investment risk, (2) there is no guaranteed minimum earning percentage (or minimum return) by the insurance company (since they are not investing the cash value in their own), and (3) the insurer still collects administrative fees, which makes this type of policy more expensive. This being said, costs of variable life insurance policies are typically offset by higher investment yields.

NOTE: Although a TOLI avoids this issue since the settlor can select a viable trustee, Variable Life Insurance is not appropriate if the owner cannot monitor investments, has a low-risk tolerance, and does not intend to hold the policy for at least 10 years.

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On the other hand, if this policy’s cash value falls below a termination threshold, the future payments needed to keep the policy in force can become impracticable to maintain. Moreover, there is no renewal under this policy so, if it terminates and the insured still wants insurance, the insured faces the risk of whether they are still insurable or will have to pay higher premiums because the insured is older. Thus, it is important to pay premiums and meet cash value requirements when purchasing Universal Life Insurance.

Some cool features of this type of policy (as a tradeoff for the increased risk) is that cash values can increase at a higher rate, and the insured can also withdraw money from the policy’s cash value as opposed to just taking a loan against it.  

NOTE: Secondary Guaranteed variation of Universal Life shifts the investment risk of universal life insurance to the insurance company by guaranteeing the death benefit and fixing premium costs. Thus, the policy owner is protected from the carrier’s investment risk and increased charges.

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With a first-to-die policy, the proceeds are paid at the death of the first spouse to die, whereas second-to-die policies pay proceeds after both spouses die. Premiums with joint life are very flexible in that premiums can be payable up until first death, second death (or life), or the premiums can be set up to vanish.

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This type of policy combines Term and Whole Life Insurance, and the dividends earned are used to buy additional paid-up whole life insurance that ultimately replaces the term insurance.

This product is substantially more sensitive to how well the insurance company operates financially because the insured takes the risk that, if the company has poor mortality or investment experience (after the guaranty maximum premium expires), (1) there might be insufficient funds to buy paid-up additions, and/or (2) the company will substantially increase the term premium. As a result, the premium in a blended product does not feature the guaranteed level premium found in other whole-life policies.

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Current Assumption Whole Life Insurance is also known as Interest-Sensitive Whole Life, and offers a level premium that remains fixed for a period of time. At the end of the period, the premium amount (and possibly death benefit) will be reevaluated based on the policy’s cash value, which directly correlates with the insurer’s profitability (whether it collectively beat investment projections, and accurately assessed policy lapse rates and mortality rates).

Thus, if the insurance company exceeded expectations, premiums will likely decrease, whereas if the insurance did not meet expectations, premiums will increase. Under each scenario, the policy owner will have some decisions to make.

If premiums increase, the insured can (1) pay premiums at the same amount and lower the death benefit, (2) pay a higher premium to keep the same death benefit, or (3) sacrifice cash value (if available) and pay the same amount of premium.

On the other hand, if the insurance company performed better than expected, the insured could (1) (if still insurable) pay the same premium amount and increase the death benefit, (2) pay the same premium amount with the same death benefit, and increase the policy’s cash value, or (3) pay a lower premium.

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Limited-Pay Whole Life insurance requires a premium payable for the life of the insured or until the policy endows, however, the premiums are designed to fully pay off the policy prior to death of the insured. Because the insurer must collect enough money to pay off the policy in a shorter period of time, premiums for this type of policy are more expensive than level-term insurance providing the same protection.

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