Satellite Offices:

Stockton
7510 Shoreline Drive Suite B-1
Stockton, CA 95219
Tel. 209-464-3408

San Ramon
2010 Crow Canyon Place
San Ramon, CA 94583
Tel. 925-829-6968

ESTATE PLANNING WITH IRREVOCABLE LIFE INSURANCE TRUSTS

If the size of your estate warrants an estate tax concern, or you have recently sold property through a charitable remainder trust, there is a simple way to provide for payment of the estate tax bill and replace the wealth that will be given to a charity through the charitable remainder trust. This advanced estate planning tool is an irrevocable life insurance trust.

In many respects, a “life insurance trust” (“ILIT”) is simply an irrevocable trust that happens to be funded with life insurance. As with any other trust, the insurance trust is a contract between a grantor and a trustee to administer certain property, in this case an insurance contract, for the benefit of named beneficiaries. The insurance trust, like other irrevocable trusts, cannot be rescinded, amended, or modified in any way after it is created. Once the grantor contributes property to the trust, he or she cannot later reclaim ownership of the property or change the terms of the trust.

The primary objective of an ILIT is to avoid inclusion of life insurance proceeds in the insured’s taxable estate. A secondary objective is to avoid inclusion in the spouse’s taxable estate. If these objectives are met, an ILIT can produce substantial transfer tax benefits even though the transfers made to the trust to pay policy premiums are subject to gift tax.

The procedure in setting up an ILIT starts with the insurance policy itself. It is important to determine whether you are insurable and the amount of the premiums. Once that step is done, then the ILIT is executed by the grantors and also signed by the ILIT trustee. Because the ILIT is irrevocable, it must have a federal taxpayer identification number and that is obtained from the IRS. This number is used to set up a bank account in the name of the ILIT.

In order for the insurance policy to stay out of your estate for estate tax purposes, you cannot have any “incidents of ownership” over the policy. This means that you cannot retain any power to change the beneficiaries, borrow against the policy or any other ownership rights. Thus, you must name someone other than yourself as the trustee of the ILIT. You will gift the money to the trustee of the ILIT and they will use that money to purchase the life insurance policy in the name of the ILIT.

It is better to have the ILIT purchase the policy rather than to transfer an existing policy to the ILIT. If an existing policy is transferred to the ILIT and you pass away within three years from that transfer, then the insurance proceeds will be included in your estate for estate tax purposes. However, for some, it may be more advantageous to transfer an existing policy if the premiums are low or you have difficulty getting another policy.

Each year you will give money to the trustees of the ILIT to make the premium payments. This transfer should qualify for the annual gift tax exclusion depending on the premium amount and the number of beneficiaries under the ILIT. However, in order for the money 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 an opportunity for 30 days to withdraw the funds from the ILIT. These notices are commonly called Crummey notices because of the case that established this procedure. If the beneficiaries are given a time frame to have immediate access to the funds, then the beneficiaries have a present interest and the transfer qualifies as a gift. However, most beneficiaries realize the purpose of the ILIT and they do not ask for the funds to be transferred to them.

The trustee of the ILIT will use the cash generated at your death from the life insurance to pay your estate tax liability. The trustee of the ILIT cannot pay the taxes directly or the IRS may take the position that the proceeds used to pay the taxes are either a part of your taxable estate, or are being used to satisfy a debt of your estate. Either position, if successful, would result in the life insurance being included in your estate. Therefore, the trustee must purchase assets from your living trust estate to provide the cash necessary to satisfy the estate tax liability. The assets must be purchased at fair market value. The assets purchased will then become property of the life insurance trust and will be distributed to your beneficiaries according to its terms. Likewise, the cash paid for the estate assets will become an asset of your living trust estate.

Drobny Law Offices, Inc. would be delighted to answer any questions you may have regarding ILITs and assist you in implementing one for your estate plan.

Home | Attorney Bios | Articles | Seminar/Events | Contact Us