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Wealth Replacement Trusts (WRTs) are often created in tandem with Charitable Remainder Trusts. This two-trust plan allows clients to satisfy philanthropic goals, reduce taxes, and preserve the inheritance of family members or other loved ones. Wealth Replacement Trusts, also known as Irrevocable Life Insurance Trusts (ILITs), are trusts funded with a life insurance policy that can be used upon the death of the grantor(s) to create liquidity in an estate or to make up for the lost inheritance of a gift given to a charitable organization by way of a Charitable Remainder Trust. Wealth Replacement Trusts can be used effectively to reduce the size of the taxable estate and to provide a source of tax-free funds to pay estate taxes and other liabilities upon death.
Ordinarily, the face value of a life insurance policy is includible in the estate for estate tax purposes. A WRT, however, removes the policy from the estate, thereby reducing estate tax liability while creating a source of wealth upon the death of the policy owners.
How It Works:
- A life insurance policy, often a second-to-die policy for a married couple, is purchased by the Wealth Replacement Trust.
- The trustor funds the trust, which enables the trust to purchase the policy in its own name, and enables the trust to pay policy premiums. Income from a Charitable Remainder Trust is often used to pay annual premiums. Policy premiums may also be paid with gifts to children or other potential beneficiaries of the proceeds, using annual-exclusion gifting to avoid gift tax consequences.
- An existing insurance policy may be transferred to a Wealth Replacement Trust, but care should be taken to make sure that the trustor irrevocably relinquishes all control of the policy to the trust. An attorney should be retained to ensure that this intent is carried out effectively, and that all tax consequences of the transfer are discussed beforehand.
- The life insurance proceeds are owned by the trust, and therefore are not subject to estate taxes on the death of either spouse.
- A WRT is irrevocable, which means that you cannot cancel the insurance policy, change the beneficiary, borrow against the policy or otherwise alter the policy terms if circumstances change.
- The size of the policy in the trust should be determined based upon the amount of the charitable gift to be replaced, if any, insurability of the policy owner, and other needs factors, as particular circumstances require.
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