Estate Planning with an Irrevocable Life Insurance Trust

by Mark A. Krohn, Esq., Partner

Perhaps one of the most overlooked estate planning tools is the Irrevocable Life Insurance Trust (“ILIT”). Perhaps this is because of a lack of understanding of their simplicity and effectiveness.

What is an Irrevocable Life Insurance Trust?
An ILET involves one or more individuals or a trust company appointed to act as trustee, a grantor, and at least one beneficiary. The trust holds life insurance in a manner that avoids estate taxes.

How Does This Arrangement Work?
Normally, the Grantor of the trust gives life insurance to the trust or provides money for the trust to purchase life insurance. When the insured/Grantor dies, the trustee can hold the insurance monies for the benefit of the Grantor’s beneficiaries.

How Does an ILIT Compare to a Revocable Living Trust?
Unlike in a revocable trust, the insured/Grantor will not possess the power to revoke or amend the trust or control its assets. Both the revocable trust and the LIT are often times included in an estate plan and work together complementing each other by providing the flexibility of a revocable trust coupled by the asset protection of an irrevocable trust.

Who Can Be The Trustee of the ILIT?
The insured/Grantor should not serve as trustee to assure that the life insurance proceeds are not included in his or her estate. If a second-to-die insurance policy is held neither the Grantor/insured nor his or her spouse should serve as trustee. However, after the Grantor/insured dies, the insured’s spouse should serve as trustee provided that the benefits to the surviving spouse are limited to, for example, the spouse’s health, education, and support.

How Does A Surviving Spouse Benefit?
As mentioned above, a surviving spouse can serve as trustee of the ILIT after the insured/Grantor’s death and still receive income from the trust and also monies for his or her health, education, and support. In addition, the surviving spouse may withdraw up to five (5%) percent of the principal per year. Other benefits to the surviving spouse include having protection from creditors, remarriages, and reckless spending or investing.

What If Existing Life Insurance Policies Are Transferred Into the ILIT?
Normally this is not a problem. However, the transfer of an insurance policy to an ILIT is a taxable gift. As long as the value of the policy does not exceed the annual exclusion amount (currently $12,000 per person) and otherwise qualifies for the annual exclusion, no gift tax will be due. Secondly, there exists a “three-year rule” whereby a policy owned by a person will be taxable in that person’s estate for estate tax purposes unless the person has given up all ownership rights in that policy at least three (3) years before death. At Jacobowitz & Gubits, LLP we often recommend that the policy be purchased by the ILIT trustee to avoid the three-year rule.

Who Should Prepare Your Irrevocable Life Insurance Trust?
Only a tax attorney should prepare and help maintain an ILIT. There are many complex issues that relate to the trust and the coordination of the trust with the balance of your estate plan. There exist many horrible examples of individuals who have paid for an insurance trust prepared by someone other than a tax attorney where the result was negative rather than positive.

How Do You Determine Whether A Life Insurance Trust Will Benefit You?
You can begin by establishing your priorities in association with those matters concerning your estate plan you feel that are important. Then, you may wish to go to the library to do some related research. Or you can ask for our brochure on Estate Planning which is a good beginning source, or simply let us know about your circumstances.