Irrevocable Life Insurance Trust: What is it? Do I need one?

Posted on Tuesday, August 6th, 2013

Should I purchase life insurance? 

  • Life insurance is commonly used to replace the loss of a decedent’s income.  This is particularly important for those with dependents or significant financial liabilities where sufficient assets have not been accumulated.
  • Some business owners maintain insurance policies as part of buy-sell agreements for their company succession plans to ensure the business’ continuity after their death and, often more importantly, to provide liquidity from the business to their surviving family members.
  • Life insurance proceeds can also provide liquidity to pay estate taxes especially in instances where an estate consists largely of real estate, illiquid business interests or other assets that the family may desire to maintain.
  • Insurance can also be used in certain estate planning strategies as both a wealth replacement mechanism (i.e., for funds donated to charity, paid in taxes or left to a second spouse) as well as to enhance the effectiveness of certain advanced planning techniques, primarily through leverage of premiums relative to death benefits.

 

What is an ILIT – An Irrevocable Life Insurance Trust?

  • An ILIT is a trust, a separate entity, often established primarily to own and be the beneficiary of life insurance policies.
  • Generally, if a life insurance policy is individually owned, the proceeds will be included in the individual’s estate, possibly resulting in additional estate tax liability on the proceeds.
  • In contrast, when a properly drafted and administered ILIT is the owner and beneficiary of a life insurance policy, the proceeds should not be included in the decedent’s estate. 
  • The ILIT should be drafted by attorney to meet individual specific testamentary goals.
  • Typically, the proceeds will provide for the heirs of the decedent while minimizing transfer taxes and providing other asset protection benefits.

 

Do I need an ILIT?

  • If your estate including death benefits on personally-owned life insurance exceeds estate tax exemption levels (currently 5.25MM per individual and $10.5MM per couple), an ILIT could mean your heirs get significantly more (i.e., 50%) of your insurance proceeds.
  • If your estate including life insurance proceeds is under estate tax exemption levels but you already have an ILIT in place, the non-tax benefits of an ILIT may justify keeping the trust in tact if the insurance policy will be maintained.

 

I have an ILIT – what should I do now?  To be respected by the IRS, it is important the trustee adheres to certain administrative procedures.  Procedures may vary for different trusts; therefore, we strongly recommend consulting with your attorney to confirm specific best practices.   In most cases, the following may apply:

  • Any new policies should be obtained with the trust as owner and beneficiary.   (Existing policies may be assigned to the trust however they may be included in the original owner’s estate if death occurs within 3 years of transfer.)
  • In most cases, a tax identification number should be requested for the trust.  A CPA and/or tax attorney should be consulted regarding required tax filings, including whether gift tax returns may be necessary to report gifts for premium contributions to the trust and/or policies transferred to the trust, as well as other tax elections that may be available.
  • A bank account should be opened in the name of the trust to receive contributions for premiums.  Care should be given to the original source of the premium – i.e., joint versus individual accounts.  (In most cases, it should be from the individual account of the insured.)
  • Premium contributions should remain in the trust account for a minimum of 30 days before payment by trustee to the insurance company to allow time for Crummey notices to be given to beneficiaries if applicable.
  • Crummey notices – It is often desirable for a gift to qualify for the annual gift tax exclusion (currently, $14,000 per donor to each donee).  In order for a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” For a gift to a trust to qualify as a “present interest,” trusts are often drafted with Crummey provisions which give the beneficiary the right to withdraw their respective share of the gift.  (The term “Crummey” comes from a court case on the issue.)  Typically, the trustee is required to provide beneficiaries with Crummey notices to make them aware of their right when contributions are made.  For minors, notices should be provided to the minors’ representative who in many cases may be the same as the trustee in which notice may be “deemed” without actually sending written notices.  In some cases, a one-time notice may be sufficient.  The drafting attorney should be able to provide sample Crummey notices and verify specific procedures for individual ILITs.
  • To simplify required notices, premium payments should not be made more frequently than annual basis.
  • Underlying policy performance should be monitored periodically.

Bottom line — we can help assess whether you may be over or underinsured based on current tax law and your personal situation.  We have trusted industry resources if it is determined you need additional coverage.  Alternatively, if your insurance needs have decreased, we can help evaluate options for existing policies such as reduced paid up death benefit, conversion to a different type of policy or surrender given your particular situation.

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Date of publication:  August 2013

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