What is an Irrevocable Life Insurance Trust?
What does an irrevocable life insurance trust, and do you need one? How does it benefit you, and why would you want to have one? [music] Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), host of the Retirement Income Show, and author of the upcoming book, Core Four.
Before we get started here, I want everyone to take a minute to comment down below whether it’s important to you, after you’ve taken care of your retirement needs, and you, and your family, if there’s money left over for your kids, or you don’t care how much money is left over for your kids. I always like to get feedback from clients to see where they are, because it helps us of course, when we build the investment plans, or the insurance plans, and the income plans. For me, it’s 50/50 from my experience with my clients. Comment down below, let me know if you care how much is left for your kids, or you hope you bounce your last check. Curious to see the results here.
An irrevocable life insurance trust, this is an estate-planning tool for those of you that do care how much money is left for your kids and grandkids. Me personally, I think it’s going to be much more difficult for your kids, your grandkids, depending on how old you are, to get ahead over the next 40, 50, 60 years in this country than it was for me or it was for you, and the big reason I believe is automation. We are going to go through a new industrial revolution, a technological industrial revolution where many of the jobs that are available today, I believe simply won’t be available in the future. This is something not enough people are talking about.
If you care about how much money is left for your family, an irrevocable life insurance trust could be something that is of value to you. Here’s the concept, if you have a $2 million estate today– And here in Houston, we have a lot of people who retire from the oil and gas companies, so this is very common for us to see. Your 401K, maybe you have a lump sum pension that you have rolled over, you have your home, you have some savings, so a $2 million estate is not uncommon for us to see.
What we have to decide when building our retirement income investment and tax plans based on your life expectancy, average life expectancy if you have good health, poor health, et cetera, what will the value of your estate be in the future? In 30 years, after your income, after the taxes that you’ve paid, when we get towards the end of your life, let’s assume that your estate is worth $6 million.
Now you say, “Troy, it’s never going to be worth $6 million.” Bear with me. If you just understand basic time value of money, with a $2 million estate, if we earn an average of 7% interest, in 10 years, that’s going to be worth $4 million. In 20 years, that’s going to be worth $8 million, and in 30 years, that’s going to be worth $16 million. At about 7% interest, your money doubles every 10 years. Now, of course, you have to take income, you have to pay taxes. With a 30-year time frame, a $6 million estate if you’re starting with $2 million, isn’t that unreasonable.
If you pass away today, you can pass on over $20 million and owe no estate taxes, but it wasn’t that long ago where the estate tax amount that you could pass on without owing any taxes was as little as $600,000. We’re going to make some assumptions here because we’re talking 30 years in the future, and the laws are going to change many times from now until then. Let’s assume you can pass on– In the future, there’s a $1 million estate tax exemption, that would leave you with a taxable estate of $5 million. At a historical 50% estate tax rate, that means you would owe $2.5 million dollars in taxes. If you do absolutely no estate planning, and you pass away with a $6 million estate, your kids, you pass away with $6 million, they’re going to owe $2.5 million in estate taxes. They’re left with $3.5 million dollars.
Let me make this very clear, if you do not have a plan, the government has a plan. You have to choose, do you want the government’s plan, or are you going to take the time to build your own plan? The government’s plan is to take as much of your money as they possibly can, they need it. We’re in a big financial crisis in this country when it comes to the amount of money we spend, the debts we’re accumulating, and the annual spending deficit that we have, so either you have a plan, or you take the government plan. They actually plan for you not to have a plan. How an irrevocable life insurance trust works means we start to gift money outside of the estate into an ILIT, an irrevocable life insurance trust.
The reason people use life insurance for these is, we put pennies in, and we get dollars in return. This is metaphorically speaking, but let’s say we put $200,000 in over the course of maybe 10 years, so 20,000 a year. Instead of passing on $200,000 to pay a $2.5 million estate tax bill, we can use the leverage that life insurance affords. If we put $200,000 in, let’s assume that gives us over time, a $2.5 million tax-free death benefit. Now, what we’ve done is we’ve put pennies in, and we get dollars in return. What this ultimately does, when you pass away in the future, your beneficiaries can use the proceeds of the life insurance policy– You’re still going to have to pay the taxes, the $2.5 million has to go to the government to pay the taxes, but they can use the proceeds from the life insurance policy to reimburse the estate, to reimburse themselves. Now, there is effectively no estate tax due.
They don’t get $3.5 million, they are going to get all of your hard-earned $6 million passed on to them that will stay in the family. If you want a more advanced estate plan, you can even have restrictions and maintain control from beyond the grave of how much of the $6 million they can access. Let’s say you have two kids, five grandchildren, and you want to set up a plan as to how much they can access for whatever reason. With these types of trusts, you can have control from beyond the grave, but the most important thing to understand here is we’re using the irrevocable life insurance trust, we’re using pennies to buy dollars on a fully guaranteed basis in order to protect against higher estate taxes in the future.
One of the reasons why we have to put it in the trust, if we own the life insurance policy here, the death benefit would be subject to estate taxes as well. We use the trust, we gift the money into the irrevocable life insurance trust, so it is not subject to estate taxes. It will pass 100% estate tax-free if structured properly, and life insurance is always income tax-free if structured properly. By utilizing this setup, we are passing money on 100% estate tax and income-tax-free that is used down here to replenish the estate and make sure that more of your hard-earned dollars stay in your family. If it’s important to maintain control, you can have that set up and put in place as well.
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