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.

The post Trust-Owned Life Insurance: What is it and What are its Benefits? appeared first on TOLI Law Corporation.

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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The typical way to transfer funds to a life insurance trust is by utilizing the $16,000 (per donee) annual gift tax exclusion. However, in the life insurance trust context, you must provide the beneficiaries with the ability to withdraw some of the funds because the gift tax exclusions do not apply to future gifts (it must be present).

Thus, there are concerns when a life insurance trust does not have other assets and the policy has no cash value because it is likely that such a withdrawal power is illusory (there are not enough funds to pay if a beneficiary makes a withdrawal request). Although there is not much evidence showing that the IRS has attempted to go after such infractions, it is something to keep in mind when funding a TOLI.

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If the insured has already applied for the policy before the TOLI is created, it may still be possible to avoid the 3-year rule if: (1) the insured did not pay any premiums; (2) the trustee submits a replacement application before issuance; and (3) the first premium is paid by the trustee. However, the 3-year rule cannot be avoided by using a substitute application if the trust was created after the insured filed an application for insurance.

If you owned a policy for less than a year, an insurance agent may suggest using a substitute application dated after signing the TOLI that shows the trustee as the applicant and owner. This, however, will have no legal effect in avoiding the application of the 3-year rule as it is a blatant attempt to backdate a contract/get rid of a paper trail.

Lastly, to avoid further contentions that the creation of a life insurance trust involves a transfer with incidents of ownership, the trustee should not be a mere agent of the insured.

The post Why Purchasing a New Policy is Better than Transferring an Existing Policy to a Life Insurance Trust appeared first on TOLI Law Corporation.

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).

The post Transferring an Existing Policy to a Life Insurance Trust appeared first on TOLI Law Corporation.

For example, there was a case where a decedent (i.e. person who died) transferred assets to his wife over the course of 23 years. The decedent then set up a TOLI for his wife, with the remainder going to their children. Then, the husband directed his wife to create a very similar TOLI for his benefit, with the remainder going to their children. In finding that the TOLI was includable in the decedent’s estate, the United States Supreme Court held

When this situation arises, the IRS will simply uncross the TOLIs by finding a “quid pro quo,” thus, treating each spouse as if they created a TOLI and included the insurance policy proceeds in each spouse’s estate.

For these reasons, the reciprocal trust doctrine significantly limits the use of such an arrangement due to the uncertain tax treatment. If such TOLIs are desired (despite its potential risks), the terms of property distribution should be as different as possible, the TOLIs should be set up at different times, and at one TOLI should not economically benefit the other spouse.

NOTE: This does not apply in situations where the settlor does not benefit from the trust. For example, you can create two trusts for the benefit of your children, which thereby allows each spouse to be the trustee of the other spouse’s trust.

The post What not to do when Utilizing Two Life Insurance Trusts to Benefit the other Spouse appeared first on TOLI Law Corporation.

It is also not advisable for the settlor’s spouse to be the trustee, although it is possible as long as the trust does not own any insurance on the life of the spouse (including a second-to-die policy), and the spouse, as trustee, does not have powers that will result in a general power of appointment. Otherwise, the TOLI will be included in the spouse’s estate at the spouse’s death

A spouse will have a general power of appointment under the following situations: (1) when the spouse can make discretionary distributions to themself without limiting such distributions by an ascertainable standard (e.g. for health, education, support); (2) when the spouse can make distributions that discharge a support obligation of the spouse; or (3) when the spouse fails to prevent distributions to their creditors or estate. If the spouse accidentally breaks one of these rules while acting as trustee of the TOLI, insurance proceeds will be included in the taxable estate. Also, remember that the TOLI cannot be funded with community property if the spouse is a beneficiary.

Therefore, it is advisable to have an outside party, such as a trusted relative, friend, advisor (such as a Lawyer/CPA), or company offering trustee services to act as trustee to ensure compliance.

The post How to Ensure that the Death Benefit will not be Included in the Insured’s Taxable Estate (Part II) appeared first on TOLI Law Corporation.

A beneficiary with a retained interest typically arises when community property is used to fund a TOLI that names a spouse as a beneficiary. If this occurs, half of the trust estate will be included in the spouse’s taxable estate when the spouse dies. This unfortunate result can be avoided if the settlor/grantor funds the trust with separate property, which usually requires an agreement to change community property into equal shares of separate property.

Although it is possible to change community property to separate property, it is important that the spouse (named as a beneficiary) not mix the resulting separate property with community property. Otherwise, it could leave the door open to a claim by the IRS that the agreement to change the community property to separate property was illusory (e.g. done for the sole purpose of receiving a tax benefit). Moreover, it is good practice to save the separate property as an emergency fund, rather than spend it the same way you typically would, to avoid the same type of argument by the IRS.   

Although it is possible, setting up a TOLI becomes more complicated when an existing policy (already purchased with community assets) is being transferred and you still want to name your spouse as a beneficiary. One strategy is to determine the actual value of the policy (based on IRS approved practices) and have the insured use separate property to make a cash purchase of the noninsured spouse’s interest.

The post How to Ensure that the Death Benefit will not be Included in the Insured’s Taxable Estate (Part I) appeared first on TOLI Law Corporation.

The proceeds from an insurance policy are payable to the insured’s estate (even with a TOLI) if the trustee uses the funds to pay the insured’s debts, cost of estate administration, or estate taxes. Thus, a TOLI should state that the trust can lend money to or purchase assets from the insured’s estate to pay off those expenses.

As it pertains to life insurance, an “incident of ownership” will arise if the insured (1) is the trustee of the TOLI, (2) has unrestricted power to remove and replace the trustee, (3) is a beneficiary, (4) has the power to change beneficiaries, (5) has the right to borrow against the policy’s cash value or cancel the policy altogether.

When funding a TOLI with an existing life insurance policy, which would have already been included in the insured’s estate (for the reasons discussed above), will trigger a 3-year rule. The 3-year rule requires that the owner/insured of the policy survives at least 3 years from the date of transfer in order to prevent inclusion of insurance proceeds from the owner’s/insured’s taxable estate.

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