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What is a life insurance trust?

Death benefits paid on a life insurance policy pass to the beneficiaries of the policy free of income taxes. But life insurance proceeds may be subject to federal estate taxes instead. You can make sure that your life insurance pays your beneficiaries free of both federal estate taxes and income taxes by having your insurance owned by an irrevocable life insurance trust. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "Because your irrevocable life insurance trust will be considered the owner of the life insurance upon your death, the value of your life insurance will be excluded from your gross estate. There is one exception to this estate tax-free rule, however. If you transfer the ownership of an existing policy on your life to your irrevocable life insurance trust and you die within three years of the transfer, the entire value of the policy is brought back into your estate for federal estate tax purposes." To guard against such a trap, some financial experts say that you should have the trustee of your irrevocable life insurance trust purchase a new policy on your life so that if you die within three years, the policy is excluded from your estate.