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Advanced planning

How a life insurance trust works: an illustrated example

A properly structured life insurance trust can keep policy proceeds outside your taxable estate and provide resources for your beneficiaries. The example below compares owning a policy yourself with having a trust own it.

Ownership arrangements, retained rights, premium gifts, and the timing of policy transfers affect the tax treatment.

Hypothetical example · Life insurance trust

The ownership of a $10 million policy can make a meaningful difference.

Life insurance is often intended to give a family financial breathing room. The way a policy is owned can affect how much of that benefit remains available after estate taxes.

Diagram: you make gifts to a life insurance trust to pay premiums, the trust owns a 10 million dollar policy, and a properly structured trust may keep the proceeds outside your taxable estate. Youthe insured The trustlife insurance trust Your familythe beneficiaries Gifts for premiumshandled to meet tax requirements The trust owns the policy If in your estate: $4M taxin this example, at a 40% rate Proceeds may stay outsideyour taxable estate, if properly structured Hypothetical illustration, not a client result. Assumptions are listed below the example.
  1. Step 1

    Fund the trust

    You make gifts to the trust to pay the premiums. Whether they qualify for annual exclusion treatment depends on how they are structured and handled.

  2. Step 2

    The trust owns the policy

    The trust owns a $10 million policy on your life and is its beneficiary.

  3. Step 3

    Why ownership matters

    Suppose your estate is already large enough that an additional $10 million insurance benefit would be taxed entirely at a 40% federal estate-tax rate. Including that benefit in your estate could add $4 million in estate tax.

  4. Step 4

    Resources for your family

    A properly structured and administered life insurance trust may keep the proceeds outside your taxable estate, preserving more resources for your beneficiaries.

Ownership mattersRetained policy rights and beneficiary arrangements can affect the tax result.
Timing mattersTransferring an existing policy within three years of the insured’s death can cause inclusion in the estate.
LiquidityProceeds can help a family address estate expenses without a hurried sale.

Hypothetical comparison, not a client result. Assumes the entire $10 million benefit would otherwise be subject to federal estate tax at 40%, without offsetting exemptions or deductions. Trust ownership alone does not ensure exclusion. Retained policy rights, beneficiary arrangements, premium gifts, and transfers within three years of death can affect the result. Insurance costs and trust expenses are excluded.

This guide is general information about California and federal law, not legal or tax advice for your situation. Reading it does not create an attorney-client relationship.

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