In Maryland, there are some circumstances where your beneficiaries will be required to pay taxes on the proceeds of your life insurance. This often occurs when your estate exceeds the stipulated tax limit. However, you can control, at least to some degree, the amount of money the government can take with an irrevocable life insurance trust.
Understanding an irrevocable life insurance trust
All estate planning trusts in Maryland can either be considered revocable or irrevocable. Revocable trusts are the ones that the creator (or grantor) can change the terms or revoke while they are still alive. In contrast, irrevocable trusts cannot be amended or terminated by the grantor once created. So an irrevocable life insurance trust is simply a trust that owns the grantor’s life insurance policy, which they have given up the power to change its terms or terminate.
How irrevocable life insurance trusts work from a tax planning perspective
The proceeds of a life insurance policy are generally not subject to income taxes in Maryland because they are not derived from an activity that is engaged in for profit. However, if your estate is worth $5 million or more (or $12 million for the federal government), they’ll be considered part of your estate, consequently subject to estate taxes of up to 40% of their value when you die.
An irrevocable life insurance trust can help you minimize the amount of estate taxes that your beneficiaries will have to pay. This is because the trust owns the policy and pays the required premiums. So, the government will look at them as belonging to the trustee and not you, hence won’t be included in your estate. In addition, if the trust is structured correctly, the death benefit can be paid out over time, further reducing the tax liability.
If you are looking for ways to minimize the amount of taxes your beneficiaries will have to pay on your life insurance policy, an irrevocable life insurance trust may be a good option. However, it is important to note that this type of trust is permanent and cannot be revoked once it has been created. Therefore, you should only consider it if you are sure that you do not want to change the terms of the trust in the future.