There are many specialized asset-preservation strategies, some involving a combination of trusts, partnerships, and corporations. You’ll want to plan, though, before the need arises.  If you transfer assets into a trust, a family limited partnership, or a corporation after a lawsuit is filed against you or your business, a court will likely treat the assets as though they were still in your name.

Here are three of the most common asset-preservation trusts:

1. Irrevocable life insurance trust.  In the United States, life insurance proceeds from a policy you own are counted as part of your estate for federal estate tax purposes, even if the proceeds are payable directly to your beneficiaries.  In addition, the cash value of the policy can be attached by creditors.

Both of these problems can be solved by putting your life insurance policy into an irrevocable life insurance trust.  You can fund the policy premiums with annual gifts to the trust. There will be no estate tax on the proceeds if the policy is put into the trust at least three years before you die. If the policy is put into the trust before any claims arise against you, the trust will also protect the cash value of the policy from your creditors. After you die, the trust will receive the insurance proceeds and will invest them for the benefit of the persons (usually, your spouse and children) you have named as “trust beneficiaries.”  A side benefit of this is that the policy proceeds can be held until any of the named beneficiaries, such as children or grandchildren, reach a certain age chosen in advance by you. 

2. Grantor-retained annuity trusts.  This trust is typically set up with a transfer of cash to the trust.  The cash is then invested.  As the “grantor” establishing the trust, you specify that you will receive an annuity at a specific rate – typically, around 6% – for a set number of years.  You can also specify that if you die first, your spouse will receive an annuity.  When both you and your spouse die, the remainder is then paid into trusts that will be automatically created for your children, or anyone else you specify.  Creditors cannot attach any funds other than the annuity payable to you each year.  Creditors can never attach the principal of the trust.

A variation on this trust exists where you anticipate that you may become the target of lawsuits – for instance, if you are a doctor who performs high-risk procedures.  Then the annuity can be made payable to your spouse, completely protecting it from creditors.  You can specify that if your spouse dies first, you will receive the annuity.  Although your annuity will then be available for creditors to attach, the trust principal will still be preserved.

3. Family limited partnership trust.  A family limited partnership trust usually combines business operations with asset protection and estate planning, and typically involves layering at least two entities.  First, assets are put into a family limited partnership.  These assets usually include your business, or the stock of your business.  Because creditors could foreclose on a partnership interest owned by you, the partnership is instead owned by a family trust.  In your status as trustee of the family trust, you control the trust, and therefore, the partnership, and therefore, your business.  This is a complicated but very flexible arrangement which can protect different assets from creditors, and each asset can be governed by its own terms.  It can also minimize estate tax if carefully drafted.

Asset protection is a complicated area of law, and each person’s finances, tax situation, and business must be considered on its own merits. If you would like the experienced business and estate planning attorneys at San Diego Law Firm to evaluate your particular situation for the suitability of asset-preservation strategies, please call us for an appointment at (619) 794-0243.  We look forward to helping you.

Knowing loved ones will be financially cared for in the event of death can give a family breadwinner great peace of mind.  Life insurance is a valuable tool in any estate plan because of the benefits it provides. 

First, life insurance can help family members bare the financial consequences of an unexpected death.  The National Funeral Directors Association approximates the average expense of a funeral to be upwards of $6500.00. This is a cost that may be prohibitive unless there is a reliable and immediate source of funds which can be used to pay for high funeral expenses.

Second, a life insurance policy ensures the loved ones’ future financial security. For example, if the family’s primary income earner passes away, a well funded life insurance policy will provide money to meet current and future household expenses such as mortgage and education costs. If you want to ensure that all of your life insurance proceeds are used for the purposes which you intend, you may want to consider having your attorney prepare an Irrevocable Life Insurance Trust for you.

Life Insurance and Estate Tax

What you may not know is that the proceeds paid on a life insurance policy are included in an estate (everything you own when you die) for estate tax purposes.  This means the size of the estate is actually inflated by the face value of the policy.  For example, if you have real estate, bank accounts, and stocks that add up to $2,000,000 you may think that only $2,000,000 of the estate will be subject to the federal estate tax rate. However, if you have $500,000 worth of life insurance it is considered part of your estate, and estate taxes will be due on $2,500,000!  The underlying reason life insurance benefits are included in an estate is because the policy holder is deemed to “own” the proceeds so that the IRS can fully tax those proceeds as part the deceased persons estate at death.  

Reduce Estate Tax With a Life Insurance Trust

One way to avoid tax on life insurance proceeds is to establish an Irrevocable Life Insurance Trust, or ILIT.   Under an ILIT, the life insurance policy is not “owned” by the decedent or his or her spouse.  Therefore, the proceeds are not considered part of the decedent’s estate. This is done by transferring ownership of a life insurance policy to the trustee of an ILIT.  After ownership interest of the life insurance policy is transferred to the trustee, you’ll no longer “own” the policy and the proceeds can’t be taxed as being part of your estate when you die.

Advantages and Disadvantages

However, there are a few drawbacks to consider in setting up an ILIT. For example:

• You can’t change the beneficiary of the policy:  If you as an insured want the flexibility to deal with changed family circumstances, an ILIT may not be the right choice for you because after the ILIT is created, the insured gives up the right to change the beneficiary of the policy.
• You can’t borrow from the policy:  If your policy normally allows you to borrow against the policy or make cash withdrawals from it, under an ILIT you will no longer be able to do this.
• Transferring an existing policy to the trust could be complicated:  If you already have a life insurance policy, ownership can be transferred. But, if the insured dies within 3 years of the date from which the policy was transferred, the life insurance policy will be included in the estate for tax purposes anyway!  However, depending on a number of factors, your attorney may be able to avoid this problem with a “fail-safe” clause that ensures that the proceeds of a transferred policy are held separately under an ILIT. 

Our estate planning attorneys at San Diego Law Firm know the complexities involved in making sure loved ones and assets will be cared for and protected in the worst-case scenario for a family. We can answer your questions about life insurance trusts and other estate planning tools that you can use to ensure that 100% of life insurance proceeds go to the beneficiaries instead of to paying estate taxes.  Also, we can look over your existing estate plan to make sure that all potential “fail-safe” mechanisms are in place.  Call us at 619-794-0243 for advice and a consultation on ILIT issues.