Life Insurance and the Wealth Replacement Trust

In our prior posts, we discussed how there are many Uses of Life Insurance in Estate Planning, including Estate Creation; Liquidity to Pay Estate Tax; Estate Equalization; and Using Life Insurance to Save the Family Business.

Now let’s look at one of the very best ways to leverage the value of both Life Insurance and Charitable Giving:

Using Life Insurance in a Wealth Replacement Trust

Charitable Giving is one of the best ways for families to deal with Estate Tax issues, as well as to leave a positive legacy for one’s family and community.

The Charitable Remainder Trust (CRT) offers three levels of potential Tax savings: (1) Deferral of Capital Gains Tax; (2) Immediate Income Tax deduction; and (3) Estate Tax credit for amounts passing to charity at the end of the Trust.

The Charitable Lead Trust (CLT) allows a Donor to transfer property to their Children at a greatly reduced Gift Tax level, since it receives a credit for amounts going to Charity during the term of the Trust.

A Private Family Foundation or Donor Advised Fund allows Family members to direct donations to qualified recipient organizations over many years.

In addition, a Private Foundation or Donor Advised Fund can be set up to receive the Charitable Remainder at the end of the Charitable Remainder Trust, and it can also receive the annual Charitable Gift from the Charitable Lead Trust.

However, each of these techniques can have a serious drawback.

For the Charitable Remainder Trust, what happens if the Donor dies early in the CRT’s term, leaving more money to the Charity than anticipated, and depriving the family of the use of those assets?

With the Charitable Lead Trust, what happens when the family can not wait for 10, 20 or 30 years to use the money that is locked up into the CLT?

Families that are concerned about these outcomes will often use a Wealth Replacement Trust (also known as an Irrevocable Life Insurance Trust) to replace assets passing to Charity.

If the Donor of a Charitable Remainder Trust dies early, and the CRT pays more to charity than anticipated, the Wealth Replacement Trust will replace those assets with Life Insurance death benefit proceeds.

If a Charitable Lead Trust is set up for a length term of years after the Donor dies (called a Testamentary Charitable Lead Trust), the Donor can also set up a Wealth Replacement Trust with an equal amount that will pay to the beneficiaries immediately upon his passing.

That way, the Beneficiaries will have immediate use of the Life Insurance proceeds upon the Donor’s death, and also will receive the balance of the Charitable Lead Trust at the end of it’s term of years.

In both cases, Life Insurance is used in a Wealth Replacement Trust to enhance the benefits of Charitable Giving, as well as mitigating the downside of the Charitable techniques.