Life Insurance Review

End of Life Management Toolkit #4 | by Team Passare, Robert L. Shepard and Jeff A. Perry

4. Irrevocable Life Insurance Trust

To remove life insurance proceeds from your estate, you can gift the insurance policy to your children. The children will then be responsible for maintaining the policy and paying the future premiums. A better alternative may be to utilize an irrevocable life insurance trust (ILIT).

An irrevocable life insurance trust is designed to hold a life insurance policy during the insured’s lifetime. When the insured passes away, the proceeds are distributed to the family or other beneficiaries such as a charity or other entity.

The insured cannot be the trustee of the ILIT. The insured would name a trustee and give the trustee enough money each year to pay the policy premiums. The irrevocable insurance trust would be both the owner and the beneficiary of the life insurance policy. Then, each year the insured could make a gift to the trust adequate to fund the next year’s insurance premiums.

The life insurance trust is usually unfunded, except for the amount needed to pay the annual premium. The trust usually contains a “Crummey withdrawal” provision. This provision gives the beneficiaries of the trust the right to withdraw the amount contributed to the trust for a short period of time. It is anticipated, of course, that the beneficiary will not withdraw the amount. After the withdrawal period is over, the trustee can use the contributed funds to pay the premium.

The money for premiums is transferred to the trust, but for legal reasons, it has to be a gift. However, to be legitimate, the beneficiaries of the gift have to be allowed the option to take a withdrawal (their portion/gift) from the trust. After a specified time frame, the withdrawal period ends and they lose the option to withdraw their gift. At this time, the trustee can use the funds to pay the premium.

The consequence, should someone exercise their right under the Crummey withdrawal provision, is to withdraw their gift; the trust may no longer have the funds for the premium. It is recommended that the beneficiary speak with their advisor as to the consequences of exercising their right to withdraw under this provision.

TIP: Including the Crummey provision allows the contribution to the trust to be treated as an annual gift and excluded from gift tax up to the $14,000 annual gift tax exclusion amount.

Advantages of an Irrevocable Life Insurance Trust

The irrevocable life insurance trust can remove the insurance proceeds from both the insured’s and the surviving spouse’s estates.

  • The gift of the insurance policy to the trust gives the insured more control over the policy than would the outright policy gift.
  • The trust, like any trust, can provide for professional managem ent of the proceeds by a carefully selected trustee.

TIP: An irrevocable insurance trust is a flexible document to hold life insurance policies that can ultimately benefit the children and other beneficiaries.

Disadvantages of an Irrevocable Life Insurance Trust

There are relatively few disadvantages in making gifts of life insurance to a trust rather than making them outright.

  • One disadvantage is the cost of preparing the trust agreeme nt and possibly the annual fiduciary income tax returns and accounting fees.
  • The procedure for making the annual contributions to the trust is complicated and a record of the Crummey withdrawal letters must be maintained.
  • Finally, if the insured dies within three years of transferring an exi sting policy to a trust, the amount of the policy will be included in the insured’s gross estate. 
Using Life Insurance to Pay Taxes

For wealthy individuals or for a family with assets that cannot be easily sold to pay estate taxes, life insurance is often an important (if not critical) component of estate planning. A solution to provide funds to pay any ultimate estate tax liability is to purchase a life insurance policy in an irrevocable trust.

TIP: If your estate will have a need for cash at death and there is no source of cash, a life insurance policy can provide the alternative source to meet this estate tax need.

Now, take a few minutes to answer these helpful questions about life insurance review.
  1. What are the advantages of an ILIT?
  2. What are the disadvantages of an ILIT?
  3. Is the total value of your trust principal such that the amount that can be contributed to the trust each year and still qualify for the annual gift tax exclusion is less than an outright gift made directly to the beneficiaries?
  4. Will you need life insurance to help pay estate taxes?
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