Are you planning to leave behind a business, stocks, real estate, or other investments for your family? If you are not careful, you may leave them with the heavy burden of coming up with cash to pay estate taxes.

Estate planning can usually mitigate estate taxes when the first spouse dies, but after the surviving spouse's death, estate taxes can cost the heirs more than 55 percent of the estate's value.

One way to alleviate the difficulty of paying these taxes is through a life insurance policy commonly referred to as "second-to-die" or survivorship insurance. This type of policy insures both the husband and wife, but pays off only at the death of the surviving spouse. Because the mortality risk is spread over two lives, the cost may be substantially lower than the cost of providing the same coverage for one.

After deciding to purchase "second-to-die" insurance, the next step is to create an irrevocable life insurance trust so that the trust is the applicant, the owner, and the beneficiary of the policy. Holding the policy in a trust allows for greater flexibility in determining how the insurance proceeds are used. The trust could include provisions that direct the insurance proceeds for the payment of estate taxes and other estate obligations. This may be accomplished by giving the trustee discretion to purchase estate assets or to lend money to the estate. Generally, the trustee pays the insurance premiums through the annual contributions made to the trust by the insured. The trust can be structured so that the gift taxes on these contributions are minimized.

This strategy is beneficial if a large part of the decedent's estate is made up of real estate, stock in a family business, or other assets that the family wants to retain. The insurance proceeds can be channeled to the estate from the trust in exchange for the assets of the estate. This not only solves the potential liquidity problems caused by the estate tax, but it also allows the insurance proceeds to avoid estate tax. And since life insurance proceeds are excluded from income tax, this is an added benefit.

Although these benefits are important, holding insurance in trust has its drawbacks. First, the insured must give up ownership of the policy. And second, the insurance can neither be payable to the insured nor for the benefit of the estate. The insured loses some control of the policy, including the right to change the designation of the beneficiary. In light of the possible change in parents' attitudes towards their children, this aspect should be carefully weighed.

As with any investment, the potential benefits must be compared with the projected costs and possible alternatives. In situations where proceeds are needed at the death of the first spouse, purchasing separate policies may be advisable. Whether or not you should create a life insurance trust is a question that should only be answered on a case-by-case basis.