Irrevocable Life Insurance Trust: Is It Right For You?
The Irrevocable Life Insurance Trust can be an effective strategy for transferring wealth to your beneficiaries without income tax or estate tax.
An Irrevocable Life Insurance Trust (ILIT) is designed so that death benefits will be income tax- and estate tax-free because they remain outside of your taxable estate. A series of relatively small gifts now can result in a much larger tax-free benefit at your death.
How Does It Work?
You make annual exclusion gifts—up to $15,000 per beneficiary in 2019 to an irrevocable trust. You must then notify the beneficiaries of their right to withdraw the gift for a limited amount of time. The amount of time to withdraw may vary, but is typically 15-30 days. This temporary right to withdraw creates a “present interest” in the gift and allows the ILIT to qualify for the annual gift tax exclusion. Beneficiaries generally realize that it is not in their best interest to withdraw the gift.
An independent trustee then uses these gifts to acquire life insurance on you. Because the ILIT is the insurance policy’s owner, the death benefits are not considered part of your taxable estate. At the time of the ILIT’s creation you have control over how and to whom the death benefits are to be distributed.
For example, you may design your ILIT to:
Is This Strategy Right For You?
If you answer ‘yes’ to all these questions, an ILIT may be a wise choice for you and your family.
Frequently Asked Questions
Do I really need a trust? Why not let children own the policy?
You do not have to establish a trust. But consider what would happen to the policy if a child gets divorced or has problems with creditors. Having a trust own the policy avoids potential problems that could affect your children. In addition, an ILIT provides a centralized point of administration so that your children do not have to coordinate responsibility for paying premiums and managing the policy. Finally, an ILIT ensures that the death benefit will be used according to your directions as opposed to letting children do whatever they please with the death benefit.
What is “second to die” life insurance and when is it used?
This covers two lives in one policy with the proceeds payable at the second death. It is most commonly used as part of a plan to efficiently transfer wealth between generations, as opposed to single-life insurance which is commonly used to replace the income lost when a wage-earner dies, and premiums are typically lower than for single-life policies on either spouse.
Can I transfer existing life insurance policies to an ILIT to get them out of my taxable estate?
Yes. The death benefits will still be included in your taxable estate if you die within three years of making the transfer. In most cases, the gift’s value will be somewhat greater than the policy’s cash value.
Can an ILIT hold assets in addition to a life insurance policy?
Yes. Income from the additional trust assets can be used to pay policy premiums which can reduce or eliminate the need to make annual gifts to the trust. By picking-up the tax liability, you reduce your taxable estate without making an additional gift and therefore, all of the trust income is available to fund premiums without being reduced by taxes.
What if I change my mind or want to disinherit one of the beneficiaries? Can I change the trust?
No. The trust is irrevocable; you cannot change the terms. You may, however, stop funding the trust, but any existing trust assets would still be used for beneficiaries according to the trust’s terms.
What is a “Crummey letter”?
It is a written notice sent to ILIT beneficiaries which advises them that a gift has been made and that they have a limited amount of time to withdraw funds from the ILIT—typically 15-30 days. These notices get their name from the tax court case, Crummey v. Commissioner.
Why are Crummey letters required?
To qualify for the gift-tax annual exclusion, tax law requires that beneficiaries have a “present interest” in a gift, meaning that they must have some real—even if limited—right to enjoy the gift today. A Crummey letter provides proof that the beneficiaries have been notified, qualifying the gift for the annual exclusion. Beneficiaries often realize that it is in their long-term best interest to forgo their withdrawal rights—be sure to speak with your attorney about trust provisions that can give you flexibility to deal with short-term problems
Choosing a Trustee
As a general rule, a spouse or anyone who might provide funds to the ILIT should not be named as a trustee. A family member or trusted individual may act as trustee, but the administrative and record keeping requirements may prove burdensome. A corporate trustee has the staff and systems in place to handle these duties efficiently. Many people like the convenience of a corporate trustee who sends out gift notices, maintains records, and reviews the insurance policy on a regular basis.
In general, implementation of this strategy consists of the following steps:
Wintrust Wealth Management offers a comprehensive suite of trust and estate planning services, including ILITs, through its trust affiliate, The Chicago Trust Company, N.A. Talk to your Wintrust Wealth Management professional to learn more and determine if an ILIT is an appropriate estate planning option for you.
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