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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
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