Irrevocable Life Insurance Trust

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1 What exactly is an ILIT? An ILIT, like most trusts, is simply a holding device. It owns your life insurance policy for you, removing it from your estate. As its name suggests, the ILIT is irrevocable. That means once you've created it and placed an insurance policy inside it, you can't take the policy back in your own name or make changes to it. But you can closely control many other aspects of the ILIT. For instance you can dictate who your initial beneficiaries will be, and you can define the terms under which they will receive benefits. You can choose the Trustee (or Trustees) who will manage your ILIT. It's all up to you. An ILIT provides you, your loved ones, and your estate with considerable advantages. But these benefits can only be achieved if the ILIT is designed properly and specific guidelines are followed carefully. We discuss the steps you'll need to take in detail over the next few pages. What's the first step? The process will begin when you sit down with your advisor and provide them with important information that will be used to design your ILIT. For example, as described above, you'll tell them who you want your beneficiaries to be, You'll name your Trustees, and you'll tell them under what circumstances you'll want your beneficiaries to receive money from the ILIT. Introduction to The Irrevocable Life Insurance Trust 1

2 What conditions can we establish for policy distributions after our deaths? It's really up to you. You can, for instance, have the policy's proceeds paid out immediately to one or all of your beneficiaries. Or you can specify that your beneficiaries receive monthly or annual distributions. You may even dictate that beneficiaries receive money when they attain certain milestones. For example, you can provide for a large distribution when a beneficiary graduates from college, buys a first home, marries, or has a child. You can also build in flexibility, so that your Trustee has the discretion to provide distributions when your beneficiary needs it for a special purpose such as starting a new business, or even a once-in- a- lifetime investment opportunity. If your beneficiary is on government aid, your Trustee can carefully control how distributions from your policy are used in such a way as not to interfere with your beneficiary's eligibility to receive government benefits. The point to remember is this: You have the opportunity to carefully control how, when, and why your beneficiaries receive the proceeds of your life insurance policy. That gives you the power to ensure that your policy is used in the best possible way on behalf of your loved ones. Introduction to The Irrevocable Life Insurance Trust 2

3 Who should we name as beneficiaries? Again, the choice is completely up to you, although most people name their children, grandchildren or other close family members. Who should serve as Trustee? With many types of trusts it's perfectly fine for you or your spouse---or both of you---to serve as your own Trustees. But that's not the case with the ILIT. If you or your spouse are an insured of a life insurance policy that is owned by an ILIT, and you also serve as the Trustee of the ILIT, then the IRS may decide that the policy hasn't left your estate after all. Instead, the IRS may count it as part of your estate, which can impact your estate tax liability. A better solution is to ask a trusted professional advisor to serve as a Trustee. A financial advisor, for example, would be an appropriate choice. Of course, you may name more than one Trustee, so you may also want to name a family member as a Trustee. If your spouse is not an insured, he or she may serve in this capacity. That way, you can be assured that your family's goals are met while also under the expert guidance of a professional. Also, consider that the Trustee you name today is just as mortal as you are. Death or disability may make your Trustee unable to serve in that capacity someday in the future. For that reason, you should probably also Introduction to The Irrevocable Life Insurance Trust 3

4 name a Successor Trustee in case your first choice is no longer able to serve in that capacity. What does the Trustee do? The Trustee manages the ILIT for you on your behalf. Your Trustee will follow your directions, as you've initially set forth in the ILIT's documents. While you and your spouse are alive, your Trustee will take the money you transfer to the ILIT each year and use it to pay your insurance premiums. Your Trustee may also oversee such administrative duties as the annual notification to your beneficiaries (called a "Crummey Letter"), and the filing of the ILIT's tax return, if necessary. Once you've passed away, your Trustee will oversee distribution of the policy's proceeds, according to the directions you've provided in the trust. *Check with your tax accountant regarding the filing of a tax return What's the next step in setting up an ILIT? Once you've worked with your estate-planning advisor to draft your ILIT, named your beneficiaries and your Trustee (or Trustees), the next step is to acquire a life insurance policy. You'll go about this process just as you would normally, except that the owner and beneficiary of your policy will be your ILIT. Also, you won't pay the insurance premiums directly. Instead, your Trustee will handle the actual transaction of paying your premiums to the insurance company. Introduction to The Irrevocable Life Insurance Trust 4

5 What kind of policy should be used for the ILIT? You can use an individual life policy---that is, one that insures the life of just one individual. Or, if you and your spouse are both living, you can use a second-todie (also known as a "survivorship") policy. This kind of policy pays out a death benefit only after both spouses have passed away. Just remember, however, that if you and your spouse are both covered by an insurance policy owned by your ILIT, neither of you can serve as Trustees. Can we use an existing policy? Yes! Just remember that if you die within three years of making the transfer of ownership of the policy, the IRS will include the policy in your estate for estate tax purposes. Also, there are gift-tax considerations if an existing policy is used for an ILIT and policy cash values are being transferred. Despite these issues, however, you may still find that transferring an existing policy from your estate into an ILIT is well worth it. * Check with your tax accountant regarding gift taxes Introduction to The Irrevocable Life Insurance Trust 5

6 How do we make the premium payments each year? Each year you will transfer enough cash to your ILIT to pay your annual insurance premium. Once you've made the cash transfer, your Trustee will send your payment on to your insurance carrier in time to keep your policy in force. As long as your premium payment follows the "gifting" guidelines, as described below, there will be no gift taxes incurred by either you or your beneficiaries. What are the rules for "gifting"? The ILIT works so well because it takes advantage of the tax break allowed for gifts called the annual "gift tax exclusion". Each year, you may give away up to $14,000 to an individual completely gift-tax free. You can give $14,000 gifts, as adjusted for inflation to as many people as you like. A married couple can give an individual a combined $28,000 annually, gift-tax free. There is no limit to the total number of gifts the couple can make so long as it doesn t exceed $14,000 per person per year. You may, of course, give someone more than $14,000 a year but the excess will be applied toward your lifetime estate tax exemption of $5 million dollars each. The last remaining requirement for the gift tax exclusion is that you must give away a "present interest" in your gift. That is, the recipient of your gift must have access to it now, not Introduction to The Irrevocable Life Insurance Trust 6

7 sometime in the future. Each year, the annual premium payment you make is considered a gift to the beneficiaries you've named for your life insurance policy. As long as the premium payments equal no more than $28,000 per beneficiary (assuming that both you and your spouse are making the gift), no gift taxes will be due. As you might imagine $28,000 per beneficiary buys a lot of life insurance. The fact is, you probably won't spend anywhere near this amount on your annual life insurance premiums. So, you may very well have money left over that you can give to your beneficiaries in other ways each year. What is a "Crummey Letter"? A Crummey Letter is an important ingredient in making your ILIT work as a gift tax-free tool for your beneficiaries. we previously stated that for the gift tax exclusion to apply, your premium payment had to be a gift of a "present interest". Gifts of "future interest", such as money you might put in trust for a child, are not entitled to a gift tax exclusion. You might think that premiums paid for an insurance policy your beneficiaries will receive someday in the future are also gifts of "future interest" and thus, not eligible for the gift tax exclusion. Fortunately, you can qualify for the gift tax exclusion on your insurance premium each year as long as you send your beneficiaries written notice of what you've done. This written notice is called Introduction to The Irrevocable Life Insurance Trust 7

8 a "Crummey Letter", named after the individual who challenged the IRS and won the right to apply his annual insurance premiums toward his gift tax exclusion. The Crummey Letter must be sent to your beneficiaries to notify them when you've deposited money into your ILIT. It must also give them a specific period, usually 30 days, to withdraw this money from the ILIT. If, after 30 days have elapsed and the beneficiaries of your ILIT have left the money in place, your Trustee is then free to use the funds to pay your annual insurance premium. As simple as it sounds, the annual Crummey Letter plays an important role. It ensures that your annual premium payments are gift tax-free. What other requirements are necessary to keep the ILIT in force? Once your ILIT has been set up and your life insurance policy acquired, there's generally very little that needs to be done in the future. Each year (or as long as premiums are due), you'll transfer cash to the ILIT, the Trustee will notify your beneficiaries of that fact with the Crummey Letter, and then the Trustees will wait the prescribed 30 days to see if the beneficiaries of your ILIT withdraw the money. When they don't, and they should be instructed in advance that they should not make the withdrawal, your Trustee will send the Introduction to The Irrevocable Life Insurance Trust 8

9 premium payment on to your life insurance company. In addition, your ILIT will need a separate Tax ID number, and a separate bank account may be necessary. In some cases, you may need to file a gift tax return. Finally, if your ILIT has earned income during the year, it may require a tax return. Your tax preparer can help you make sure these requirements are fulfilled. Will my life insurance policy be subject to probate? No, as long as you do not name your estate as your beneficiary. Once your survivor (or professional advisor) has provided your insurance company with proof of your death, the policy's proceeds are paid out directly to your beneficiaries (your ILIT). This payout generally occurs quickly, privately and usually with no legal expenses involved. Your ILIT Trustee can then distribute the insurance death benefit to the beneficiaries of the ILIT per your instructions in the ILIT. Is an ILIT-essential? There's no law that says you have to have an ILIT. But if you now have a taxable estate, or may sometime in the future, then an ILIT is the best way to reduce the estate tax liability created by your life insurance. Also, remember that the ILIT gives you tremendous control Introduction to The Irrevocable Life Insurance Trust 9

10 over how your insurance proceeds are used by your beneficiaries. Many clients who don't have taxable estates use the ILIT just to manage how their loved ones use their policy's death benefit. What about putting our life insurance policy in someone else's name? You wouldn't be the first to try this estate planning shortcut. But you may find that it takes you where you don't want to go. Here's why prudent planners usually caution against it. When you give up ownership of your life insurance policy, you give up control. And that can often lead to unintended consequences. Say, for example, that you decide to assign your life insurance policy over to your grown son, who is also the policy's beneficiary. True, you've removed the policy from your estate. But you've also set into motion other potential problems. Here are, for example, just a few of the things that might go wrong under this scenario. If your son is sued and gets into debt, his creditors could seize any cash value in your policy to satisfy their judgment against him. When your son eventually received the full death benefit, it too could be lost to satisfy a creditor's judgment. If your son were to get divorced, the policy may become subject to the divorce settlement. Your former daughter-in-law could end up with half the policy's cash value or half its death Introduction to The Irrevocable Life Insurance Trust 10

11 benefits. (Depending on your son's state of residence and the debtor protection it may provide.) Should your son die before you, your life insurance policy would become part of his estate, and its ownership could be passed on to someone you don't know or don't like, and there is little you can do to stop it. Then, there's the issue of gift taxes. If your policy had a sizable cash value when you transferred it into your son's name, or if you continue to make the premium payments each year, gift taxes may be due. We could go on, but you get the idea. Putting the ownership of your life insurance policy in someone else's name is generally not the wise solution to your estate planning goals. How do we keep our beneficiaries from withdrawing the money intended to pay the premiums each year from the ILIT? Clearly, the ILIT works best when you have the cooperation of your beneficiaries. So, you'll no doubt want to discuss this strategy with them ahead of time, before you actually go through with the creation of your ILIT. If they understand that this estate-planning tool is helping you all achieve important family goals they will be much more likely to follow your wishes in the future. Of course, there's nothing you can legally do to stop them from withdrawing the funds you transfer Introduction to The Irrevocable Life Insurance Trust 11

12 to the ILIT each year, and that leads us to the next question. What if we decide we don't want to keep the ILIT in force any longer? There's nothing requiring you to continue making insurance payments. Depending on the kind of policy you have your policy may lapse as soon as you miss your annual premium payment. Or, if your policy has cash value, these funds may be used to pay premiums until all the accumulated cash value is exhausted. The one thing you cannot do, however, is transfer a policy owned by an ILIT into your own names. So, if you think that you may need to do so someday, or if you will want to access the policy's cash value for your own purposes, you probably should reconsider the ILIT as a suitable strategy for you. Introduction to The Irrevocable Life Insurance Trust 12

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