• Estate Planning Article Series - Irrevocable Life Insurance Trust 
  • March 22, 2010 | Author: Mark W. Jordan
  • Law Firm: Drew Law Firm Co., The, A Legal Professional Association - Cincinnati Office
  •  Irrevocable Life Insurance Trust

     

    Q:  Why is an Irrevocable Life Insurance Trust (“ILIT”) useful in estate planning?

     

    A:  The ILIT holds the life insurance for many purposes, including:                  
        
    1.    avoiding estate taxes;
        
    2.    increasing the assets available to your spouse, children, and other loved ones or entities; and
        
    3.    providing liquidity to a cash strapped estate or business.

    Q:  What is an ILIT?

     A:  This is a legal instrument drafted by an attorney for the purpose of removing life insurance and sometimes other assets from your estate.  You designate your spouse, children, and other appropriate parties as the beneficiaries of the trust.  You also provide all of your detailed directions to the trustee, including how the trust should be divided, when the trustee should make payments, loans, or investments, what to do with the family business, who receives the assets at the death or disability of your original beneficiaries, and when to terminate the trust.

                 

    Q:  How does the ILIT avoid taxes?

     

    A:  The ILIT is a separate legal entity that is outside your estate.  The IRS levies an estate tax on assets within your control.  Since you have laid out all of your goals and objectives in the trust document, and because normally the only asset inside the trust during your lifetime is your life insurance, it is logical to trade off giving up control in exchange for all of the tax benefits.  The trustee will be the applicant, owner, and beneficiary of your life insurance, so the proceeds will never pass through your taxable estate.

     

         Although in many situations it is fine to have your spouse or children own and be the beneficiaries of life insurance on your life, the ILIT will keep the undistributed proceeds out of their taxable estates as well.  Properly planned ILITs will avoid estate taxes and generation skipping taxes for multiple generations.

     

         All insurance purchased directly from the insurance company is income tax free.

     

         Properly handling the payment of insurance premiums will avoid any gift taxes.  Since the trustee is the owner and beneficiary of the policy, any premium you pay will be treated as a gift to the ultimate beneficiaries of the ILIT.  As long as the ILIT beneficiaries have a right to withdraw their respective share of the premium payments (this right is referred to as a Crummey power, named after a court decision) you may use your annual gift tax exclusion ($13,000 per person since 2009) to avoid gift tax.  If your spouse consents to a split gift (treating your premium payment as if you and your spouse each paid half) you could pay up to $26,000 per beneficiary per calendar year without any gift tax.

     

    Q:  How does the ILIT help you increase the assets available for your beneficiaries?

     

    A:  The ILIT makes it easy to own one or more policies of life insurance.  The trustee has the trust document as an efficient road map to follow concerning the purchase, premium payments and distribution of the proceeds.  The trustee is an independent party, so no emotions are involved and the insurance is handled as strictly business.  Often a professional trustee from a bank or other financial institution takes care of everything.  You may feel more comfortable with a bank or trust company handling sizeable premium deposits and the investment of significant amounts of insurance proceeds.

     

    Q:  How does the ILIT provide liquidity?

     

    A:  The ILIT infuses cash into your estate by making distributions, purchases, or loans as needed.  As an example, let’s assume your estate is made up of your home, family business, and an IRA that is significantly lower than expected due to the recent recession.  Your family needs to live in the home, you want to pass on the business to the next generation, and the stock inside the IRA has fallen so low you would not want your Executor to sell it at that level, and even if the Executor did sell it there would not be enough cash to take care of your spouse and children.  The trustee of the ILIT makes appropriate distributions of cash proceeds to cover debts, taxes, and funeral expenses.  The trustee could even purchase some or all of the business with the cash proceeds and professionally run the business until the children were old enough to take over.  The trustee could also make appropriate loans to the spouse, children, and business.

     

    The early stages of estate planning are critical. If you would like to arrange an initial consultation, please contact our Cincinnati office. Our lawyers will work with you to define your goals, identify significant aspects of your unique situation, and explain your alternatives.

     

    Our estate planning attorneys: Mark W. Jordan, Robert M. Smyth, George J. ZamaryJames H. Coogan, Frederic L. Goeddel, Anthony G. Covatta, Michael D. McNeil, Nancy J. Frazier and Sybil B. Mullin.

    Related practice areas: estate planning, probate and estate administration, probate litigation, charitable trusts and foundations, business succession planning, gift and estate taxation, prenuptial agreements, division of marital assets, family law, real estate, employment law, mergers and acquisitions, and medical group representation