When it comes to estate planning in California, a trust is almost always the right tool for the job. One good example is life insurance. Trusts can reduce the tax burden that would be due on a large life insurance payout.
Trusts and taxes
Life insurance policies can lead to large lump-sum payments, which may be subject to the federal estate tax. This is not always the case. For example, estate taxes are never due on money or assets that one spouse inherits from their partner. When the surviving spouse also dies, then a certain amount of their assets are also protected from the estate tax. This amount changes annually but for 2022, it was over $12 million. However, if the value of all assets, like houses and retirement accounts, plus a life insurance payout pushes the value of the estate over that level, and the heirs are not the spouse of the original owner, then the estate taxes can take a large cut of that money.
By setting up an irrevocable life insurance trust, a family can shield any proceeds from life insurance from estate taxes. This kind of trust cannot be changed once it is created, and, therefore, it requires careful planning. However, if the tax benefits are large enough, then the estate-planning savings can make it well worth the effort. It acts as the owner of the life insurance money, and a trustee will handle the process of passing the assets on to the beneficiaries.
Irrevocable life insurance trusts are inflexible but are effective ways of protecting a large life insurance benefit from being hit with estate taxes.