Irrevocable Life Insurance Trusts
An Irrevocable Life Insurance Trust or ILIT is a specific type of trust which can be used to transfer substantial proceeds from a life insurance policy to your children or other beneficiaries free of gift and estate tax. A life insurance trust is created for the sole purpose of owning a life insurance policy. If you as the insured own a policy of life insurance, upon your death those proceeds will be part of your estate and may be subject to estate taxes. If an irrevocable trust owns the insurance policy, the insurance proceeds paid out upon your death are not considered part of your estate.How is an Irrevocable Life Insurance Created?
With an irrevocable life insurance trust, you create a trust which will acquire and hold a life insurance policy on your life. You can transfer an existing policy of insurance to the trust or you can make an initial contribution of cash to the trust which the trustee then uses to purchase the policy. The difference is that with an existing policy, if the insured dies within three years of the transfer, the policy proceeds will be included in the insured's estate. If a new policy is purchased by the trustee and the insured dies within three years, the insured is not considered to have owned the policy and therefore the proceeds are not included in the insured's estate.
Once the trust is in place, you make regular contributions to the trust which are used by the trustee to pay the insurance premiums. This transfer should qualify for the annual gift tax exclusion depending on the premium amount and the number of beneficiaries. However, in order to qualify as a gift, the beneficiaries have to have a "present interest"in the funds. This is accomplished by giving notice to the beneficiaries of the gift and then giving them the opportunity for 30 days to withdraw the funds from the trust. These notices are called Crummey notices because of a case that established this procedure. The Court in the Crummey case held that premiums are of a "present interest" if beneficiaries have even a temporary right to withdraw them. Beneficiaries rarely ask to withdraw the premiums because they realize the purpose of the ILIT.Are there any drawbacks to an ILIT?
In order for the insurance policy to remain out of your estate for estate tax purposes, you cannot have any "incidents of ownership" over the policy. Therefore, the life insurance trust must be an irrevocable trust which means you cannot revoke the trust or change the terms of the trust. Once you transfer a life insurance policy into the trust, you cannot change the beneficiary of the policy. Neither can you borrow from the policy. You cannot be the trustee of your own life insurance trust. If a professional trustee is used, there may be annual administration fees.What are the advantages of an ILIT?
Despite the drawbacks, many people feel the advantages outweigh the disadvantages. An ILIT allows you to remove from your estate significant assets and pass those on to your children or other beneficiaries free of gift tax or estate tax. If there are still estate taxes to be paid because of the value of your estate, the beneficiaries can use the insurance proceeds to pay those estate taxes without having to liquidate other assets. With the current estate tax rate of 45%, an ILIT can save thousands of dollars in taxes, depending on your situation. The proceeds do not have to go through any probate process. If you have a spouse, you can arrange for your spouse to receive income from the trust during his or her lifetime.
An Irrevocable Life Insurance Trust is an advanced estate planning tool you may want to consider if the size of your estate raises estate tax concerns. You should consult an experienced lawyer who specializes in trusts and estate planning to prepare such a trust as each ILIT should be tailored to your particular situation. In addition, you may also need a financial professional to advise you concerning the various types of life insurance products that may be appropriate for funding an ILIT. The Law Offices of Scott C. Soady, APC, can assist you with determining if your estate would benefit from an Irrevocable Life Insurance Trust and drafting a ILIT that will implement your estate planning goals.
You may contact us online, call us, or e mail us with this or any other estate planning issue. We would be pleased to offer you a complimentary in-house consultation to discuss ILITs and other legal strategies.