Irrevocable Life Insurance Trust Life Insurance Planning

Irrevocable Life Insurance Trust (ILIT)

If you are interested in transferring large amounts of wealth to your loved ones, this is the most efficient way to accomplish your goal. In many cases, you can transfer massive amounts of wealth free of federal estate and gift taxes by using this estate planning tool.

Why is it better for you to put life insurance in trust rather than owning the policy as an individual owner? There are some reasons:

  • You can control how the money can be paid to the beneficiaries. For example, you can direct extra money to be paid to a beneficiary who has a medical emergency or needs extra money to pursue educational goals;
  • You can avoid a minor beneficiary’s guardianship procedure;
  • You can prevent your beneficiary’s creditors (lawsuit plaintiffs, divorcing spouses, spendthrift propensity of the beneficiary, bankruptcy trustee, etc.) from accessing the money to a greater degree;
  • You can make sure that money will be spent for the purpose for which the policy is intended. For example, you can make sure that your young adult child will not purchase a Ferrari with the money a week after the proceeds are distributed.

An ILIT can be established in the following manner:

  1. Your lawyer draft a trust agreement;
  2. You transfer money or assets to the trust annually or in a lump sum;
  3. Trustee of the ILIT uses the assets and purchase life insurance on your life, your spouse’s life, or both. You have to make sure that trustee purchases and owns the policy, not you, in order to make sure that the policy will not be included in your estate (to avoid estate tax);
  4. The trust will be a payer, owner, and beneficiary of the life insurance policy. Then the trust will receive the policy proceeds without being subject to estate tax and income tax.

If you already have existing life insurance policies, then you can establish an ILIT in the following manner:

  1. You can transfer the policy to the trust by gift;
  2. You name the trust as the owner and beneficiary of the insurance;
  3. There is a tax rule which says that life insurance proceeds will be included in your estate and is subject to estate tax if you die within 3 years of transferring a life insurance policy. Therefore, I recommend that you purchase a term life insurance to cover the estimated estate taxes if death occurs within 3 years of the transfer, and then you can let the term policy lapse after 3 years. The cost associated with this extra protection is rather small, and the benefit is large.

Premium payments for the policy in the trust

In order to minimize the gift tax consequence, the trust agreement can include a crummey power (a tax law concept) that gives each beneficiary of a trust a right to withdraw the money you put in the trust by using the annual gift tax exemption amount (currently $13,000 x Number of beneficiaries: 2009). Crummey powers create a demand right for the beneficiary to demand an amount equal to the portion of your contribution that qualified for the annual gift tax exemption. This Crummey power works and the amount of contribution you made to the trust will cover the premium payments of the policy if the beneficiary actually does not exercise this withdrawal right. However, there cannot be a prearranged deal between you and each beneficiary. Instead, each beneficiary should be able to exercise his/her free will whether or not to withdraw the contributed amount of money. This Crummey power concept involves a very sophisticated tax law principles, which are called “5 or 5 power”, “present interest rule” and sometimes “hanging power”. If these rules are not strictly followed according to the tax laws, there will be a gift tax consequence and your goal of minimizing the gift tax consequence and maximizing the wealth preservation within family will be compromised. Therefore, I recommend that you consult an estate planning attorney who is very familiar with tax planning if you would like to establish this wonder trust. Let’s say you have a large taxable estate, and also let’s assume that you have a $1 million life insurance policy. Without a ILIT, your estate will be subject to $450,000 federal estate tax ($1 million x 45% in 2009). With a ILIT which is set up as a grantor trust (another esoteric tax law concept which requires sophisticated tax planning skills), you can transfer almost all $1 million to your beneficiaries in trust with almost no gift tax consequence.

If you are interested in establishing an Irrevocable Life Insurance Trust (ILIT), please contact our office. Why do you want extra money to go to the IRS when you can use this tool and maximize the amount of money to go to your beneficiaries instead of the IRS?

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category: Asset Protection, Trusts

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