Life Insurance Trusts
Irrevocable Life Insurance Trust (ILIT)
Common goals when purchasing life insurance are to create an estate for loved ones or to provide funds with which the estate tax can be paid. These goals are diminished if life insurance proceeds are subject to estate tax. Typically, ILITs are used when the Maker’s estate is or is expected to exceed the Applicable Exemption Amount (Unified Credit.)
The best way to minimize estate taxes on insurance proceeds is often to use an ILIT. With few exceptions life insurance proceeds are not subject to income tax. However, life insurance proceeds from policies owned by the decedent are included in the decedent’s estate for estate tax purposes.
Depending upon the ILIT’s design, an ILIT may also allow the insured’s spouse to benefit from the insurance without having to include the insurance proceeds remaining at the surviving spouse’s death in the surviving spouse’s estate. Another way to accomplish this is to have the insured’s children hold title to the policy. But this clearly exposes the policy to the children’s creditors and prevents the insured’s spouse from benefiting from the insurance proceeds. There are many design alternatives available when designing an ILIT.
If the maker of an ILIT transfers an existing life insurance policy on his or her life to the ILIT in which the maker had an incident of ownership and then dies within three years of the transfer, the life insurance proceeds are included in the maker’s estate tax calculation. The maker should know that this is a possibility if death occurs within three years of transfer.
When funding an ILIT with an existing policy, it is crucial that the insured/policy owner transfer ownership of the policy to the trustee, who in turn names the trust as beneficiary. Naming the trust as beneficiary of the policy, without a change in ownership, is insufficient to divest the insured of his or her incidents of ownership
For the above reasons, the purchase of a new insurance policy is preferred. If the trustee of an ILIT applies for the new policy and is the owner from its inception, the proceeds will not be included in the insured’s estate.
ILITs often include a Demand Right Notice provision commonly referred to as a “Crummey Letter.” Proper use of this technique allows gifts to the ILIT to qualify as a present interest gifts such that they are made within the Donor’s annual gift exclusion. Gifts to an ILIT are used to pay the necessary premiums to maintain the insurance policies.
Design alternatives should be discussed with your attorney. For information on how to get started on your estate plan or ILIT see our Estate Planning process page.