NEW YORK -- Life insurance is important for your family. While income tax does not apply to a life-insurance payout, estate tax does.

If you have a substantial policy that could push the value of your estate above the tax threshold (currently $2 million) you can create an irrevocable life-insurance trust. It is a legal entity that will own the policy while you're alive and pay the proceeds to the beneficiaries you've designated after you die. A trust works with both cash-value (whole, universal) and term policies.

Setting up such a trust is complex, so you'll need an experienced attorney to draw up the papers. You also must convince the IRS you've given up ownership of the policy so you won't be able to alter its provisions, change who the beneficiaries are or pay the premiums yourself.

The trust must be active three years before you die, so don't wait to set one up. And if you're transferring an existing policy you'll have to pay gift tax on its cash value so it's better to first set up a trust, which can then buy the policy.

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