Where Does the Trustee Get the Money to Purchase the Insurance?
The trustee gets the money from you, but in a special way. If you give the money directly to the insurance company, it could be subject to a gift tax. You also want to make sure you avoid any “incidents of ownership.” So here is what you can do:
Each year, you can gift up to $11,000 to each beneficiary of your trust with no gift tax. (If you are married, you and your spouse together can gift up to $22,000 per beneficiary.) However, instead of making the gift directly to the beneficiaries, you give it to the trustee. The trustee then notifies each trust beneficiary that a gift has been received on his or her behalf and, unless he or she elects to withdraw the gift now, the trustee will invest the funds – by paying the premium on the insurance policy.
Of course, for this to work properly, the beneficiaries must understand not to withdraw the gift now but to wait for the insurance proceeds.