What is an Irrevocable Life Insurance Trust (ILIT)?
An irrevocable life insurance trust (ILIT), as the name implies, is a vehicle for holding life insurance policies. The main goal of an ILIT is to make sure the life insurance policy proceeds will not be subject to federal (or California) death taxes at the death of the person who is insured (or their spouse). By avoiding any federal and California death taxes, you can enhance and provide for the financial security of your beneficiaries.
When the the insured passes away, the proceeds are payed to the beneficiaries, which can provide them with a pool of cash that can be used to loan more money to or purchase assets from, the grantor’s insured estate.
Because the policy is owned and held by the trustee of the trust, the proceeds of the policy are not subject to Federal or California estate tax. They do, however, still provide a source of liquidity in the decedent’s estate.
The same result can be achieved by making gifts of existing or newly purchased life insurance outright to responsible adult children. With that said, one major benefit of using a trust is that you can appoint a trustee who is understands how important it can be to have liquidity for the payment of taxes, debts, and other estate related needs. In addition, you can select a trustee that can be trusted to used the proceeds for their intended purpose.
What if the life insurance requires regular payments?
When you purchase a life insurance policy that requires you to make ongoing premium payments, a typical irrevocable life insurance trust (ILIT) plan will have the insured make annual gifts to the ILIT to cover the premium payments. In order to make each gift qualify as a “present interest gift”, and therefore come within the annual exclusion under IRC Section 2503(b) from gift tax, the overall trust will provide a “Crummy withdrawal power” to the beneficiaries (usually the grantors children) and later descendants. A married couple can “split” the gift and give each donee $28,000 in 2016 without having to pay any gift taxes.
What are Crummy withdrawal powers?
A Crummy withdrawal power provides that each time a contribution is made to the trust, the beneficiary has a temporary, but unconditional, right to demand a withdrawal from the trust of a specified amount. If the demand right is not exercised within the withdrawal period, the annual transfer for that year remains in the trust for management by the trustee or can be used in whole or in part to pay the life insurance premiums. If the demand is made, the trustee must deliver the funds to the beneficiary.
With that said, the beneficiary generally will not demand that the trustee deliver the funds to the beneficiary. Most beneficiaries recognize that such a withdrawal may affect the grantors decision as the future transfers to that trust. Once the withdrawal right lapses, the trustee is then free to use the money that was contributed to pay the premiums on the life insurance policies on the grantor (and/or the grantor’s spouse’s) life.
When should you use an Irrevocable Life Insurance Trust (ILIT)?
An irrevocable life insurance trust is an excellent estate planning tool to use whenever an individual (or couple) faces a death tax in his or her generation, and wishes to provide liquidity for payment of those taxes with life insurance without subjecting the proceeds themselves to death taxes and compounding the estate tax problems.
An irrevocable life insurance trust also allows the insured to “leverage” annual exclusion gifts, lifetime credit against the gift tax, and the insured’s generation skipping transfer (GST) tax exemption by making gifts of policies that have a low current gift value in relation to their value at the insured’s death. More specifically, a trust should be used when the donor does not have confidence that the recipients of the gifts will cooperate in retaining the policies (or their proceeds) and making them available to the donor’s estate for payment of taxes. Lastly, an ILIT is beneficial when the gifts are made to minor beneficiaries or beneficiaries who do not have the capacity or judgment to manage the policies/proceeds.
If you are concerned that your estate may be over the federal exemption amount give us a call. We work with estate planning clients throughout San Diego including Carmel Valley, Poway, Rancho Bernardo, Del Mar, La Jolla, and Encinitas. We are happy to sit down with clients to discuss the benefits of advanced estate planning. Contact us today!