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ESTATE PLANNING | Irrevocable
Life Insurance Trust (aka "ILIT")
An Irrevocable Life Insurance Trust (“ILIT”)
is a trust which owns life insurance policies. Generally,
life insurance proceeds are included on your estate for federal
estate tax purposes. Depending on the size of an estate, there
may be federal estate taxes due upon death. If the ILIT is
established and operated correctly however, the insurance
proceeds from the policy (ies) are not included in your estate
for federal estate tax purposes.
As the name indicates, an ILIT is irrevocable and its terms
cannot be amended after it is created. The ILIT will need
a trustee, which must be someone other than the person creating
the trust (“Grantor”) or a person “close”
the Grantor. The ILIT must also have beneficiaries designated
in the trust, which usually are the children of the Grantor.
Once the ILIT is created it must obtain a tax identification
number and open an account to receive “gifts”
from the Grantor. Typically, these gifts are annual payments
made to the ILIT that are equal to or less than the amount
allowed for annual gifts to any person, so as not to trigger
any federal gift tax issues. The “gifts” are then
used by the trustee to pay the premiums due on the life insurance
policy(ies).
The “gifts” made by the Grantor must also meet
other requirements in order to ensure that the life insurance
proceeds will not be subject to federal estate taxes. First,
once the gift is made, the trustee must give written notice
to the beneficiary (or guardian of a minor beneficiary) and
give the beneficiary the right to take the gift in lieu of
making the premium payment. The beneficiary will typically
have 30 days to elect to withdraw the gift amount. It is important
to explain to the beneficiary that by withdrawing these funds,
they may ultimately do more damage to their inheritance. Also,
if the beneficiary withdraws the monies, then the premium
may not be paid and may cancel the insurance policy. At the
end of the 30 day period, the trustee then uses the gifts
to pay the insurance premiums.
Upon the death of the Grantor, the ILIT, which is the beneficiary
on the policy(ies), will receive the death benefit. The insurance
proceeds can be:
• used to increase the liquidity in the
estate by purchasing estate assets for cash;
• loaned to the estate to pay off liabilities or tax
obligations;
• held in trust for the beneficiaries; or
• distributed pursuant to the terms of the ILIT.
In summary, the key benefits of an ILIT are:
• provide for liquidity without requiring
the sale of other assets;
• increase the size of the estate without increasing
estate taxes;
• allow for transfers out of the estate with minimal
or no gift tax consequences; and
• can provide for ongoing management of assets under
the terms of the trust.
There are a couple of other points to consider when implementing
an ILIT. First, the ILIT is a taxable entity that must file
its own separate tax returns each year. However, the returns
are generally simple and can be handled easily by an accountant.
Second, the transfer of an existing life insurance policy
to an ILIT may result in the policy proceeds being included
in the taxable estate if the death of the policyholder occurs
within three (3) years of the transfer. The recommended approach
is to have the ILIT acquire a new policy and then the three
year restriction would not apply.
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