Irrevocable Life Insurance Trusts

An Irrevocable Life Insurance Trust (ILIT) is a strategic estate planning tool that offers numerous benefits to high-net-worth individuals seeking to protect and distribute their assets efficiently and securely. The ILIT is a very popular type of irrevocable trust for high-net-worth individuals.

The ILIT can help mitigate estate taxes, safeguard life insurance proceeds, maintain privacy, and ensure seamless wealth transfer to beneficiaries.

An Irrevocable Life Insurance Trust (ILIT) is a legal entity created to own and manage a life insurance policy for the benefit of designated beneficiaries. Once established, the trust can be funded in two ways:

  1. The grantor transfers ownership of an existing life insurance policy to the ILIT. A downside of transferring an existing life insurance policy into the ILIT is that if the grantor dies less than three years after the transfer, the life insurance proceeds will be included in the calculation of the grantor’s estate tax. In other words, the grantor must live for a three-year period after transferring the policy to the ILIT for the proceeds to be excluded from the grantor’s gross estate.
  2. The grantor transfers money to the ILIT which is then used to pay the first premium on a new life insurance policy owned initially by the ILIT. This avoids the 3-year holding requirement that is imposed by the IRS when an existing policy is transferred to the ILIT.

With either funding method, the ILIT becomes the policy’s owner and beneficiary, and upon the grantor’s passing, the trust distributes the insurance proceeds to the beneficiaries of the ILIT, or continues to hold the proceeds for the beneficiaries, all pursuant to the terms of the trust agreement. The irrevocable life insurance trust is especially attractive because it does not require giving away your assets, other than what may be necessary to arrange for payment of annual premiums.

Crummey Provisions / Beneficiary Withdrawal Rights

If premiums on the policy owned by the ILIT are still being paid because the policy is not “paid up,” then very careful planning must be undertaken to ensure that all tax law requirements are met to make each contribution to the trust a gift of a “present interest.”

Crummey provisions (also called “beneficiary withdrawal rights”) are named after the taxpayer in a landmark court case, Crummey v. Commissioner (1968). These rights are an essential component of ILITs, as they enable gifts of money to the ILIT to qualify for the annual gift tax exclusion by allowing beneficiaries to exercise their right to withdraw trust contributions made by the grantor for a limited period, typically 30 or 60 days. Crummey provisions allow grantors of an ILIT to utilize their Annual Gift Tax Exclusion, which allows individuals to give a certain amount of money or property to another person each year without incurring any potential gift tax liability. This annual exclusion is subject to a specific limit set by the IRS, which is adjusted periodically for inflation. By utilizing the annual gift tax exclusion, the grantor can transfer a small portion of their estate to the ILIT (for the benefit of the ILIT beneficiaries) without triggering potential gift taxes. To make a gift that qualifies for the annual gift tax exclusion, it must be a gift of a “present interest,” and not a gift of a potential “future interest,” meaning that the beneficiaries must have the immediate right to use, possess, or enjoy the gift. Contributions to an irrevocable trust are generally considered future interest gifts since the beneficiaries usually do not have immediate access to the assets. A Crummey provision creates a gift of a present interest by giving each beneficiary of the ILIT a temporary withdrawal right — allowing each beneficiary a limited time to withdraw the contributed funds from the ILIT. This withdrawal right must be real and enforceable (and written notice must generally be given to each beneficiary each year), making the contributions gifts of present interests for the duration of the withdrawal period.

  1. Limited Withdrawal Period: Typically, Crummey provisions stipulate a short withdrawal period, typically 30 days, during which the beneficiaries can choose to exercise their right to withdraw the contributed funds. If a beneficiary does not exercise this right within the specified timeframe, the withdrawal opportunity lapses, and the contributed funds remain in the ILIT to fulfill its intended purpose, which is typically the payment of the annual premium on the life insurance policy owned by the ILIT.
  2. Consequences of Withdrawing Funds: In most cases, beneficiaries do not actually withdraw the contributed funds, because they understand the long-term benefits of leaving the assets in the trust. The grantor must inform the beneficiaries of the withdrawal rights to meet the present interest requirement, but the grantor will also encourage them not to exercise this option because, if they do so, the ILIT will not have enough money to pay the required life insurance premium and the policy will lapse.

By including Crummey provisions in an ILIT, the grantor can leverage the annual gift tax exclusion to transfer assets to beneficiaries efficiently while still maintaining control over how those assets are used. However, it is crucial to work with a knowledgeable estate planning attorney to ensure that Crummey provisions are drafted correctly and comply with all relevant legal requirements. As tax laws are subject to change, it is advisable to consult the latest IRS guidelines and regulations to ensure compliance with the current gift tax rules.

Mitigation of Estate Taxes

One of the primary advantages of an ILIT is its ability to reduce the taxable estate of the grantor. Life insurance policies held in the grantor’s name are subject to estate taxes upon their passing. However, by transferring ownership of the policy to an ILIT, the policy’s value is excluded from the grantor’s estate. Consequently, this can significantly reduce the potential estate tax burden, ensuring that a more substantial portion of the estate passes to the intended beneficiaries.

Liquidity to Pay Estate Taxes

Another big advantage of an ILIT is its ability to provide liquidity to pay estate taxes, given that estate taxes, when due, are owed to the IRS 9 months after death, and many estate assets are not easily made liquid and therefore can’t be used to pay the estate taxes when due.

Protection of Life Insurance Proceeds

In some cases, life insurance proceeds may be vulnerable to creditors’ claims if left directly to the beneficiaries. By using an ILIT, the proceeds are shielded from the beneficiaries’ creditors since the trust owns and controls the policy. Additionally, the ILIT can be structured to provide asset protection for the beneficiaries, safeguarding their inheritance from potential financial difficulties or lawsuits.

Control and Flexibility

Although an ILIT is irrevocable, it still offers a degree of control and flexibility to the grantor. During the trust’s establishment, the grantor can outline specific guidelines for the distribution of the insurance proceeds to the beneficiaries. The trust can be structured to distribute funds incrementally over time, ensuring that beneficiaries receive financial support throughout their lifetimes. Moreover, the grantor can designate a trustee who acts in accordance with the grantor’s wishes, managing the trust and adhering to the stipulated distribution plan. The grantor can even serve as trustee of the ILIT if desired.

Privacy and Confidentiality

Unlike a will, which becomes a public document after probate, an ILIT provides a level of privacy and confidentiality for the grantor and beneficiaries. Since the trust operates independently of the probate process, details regarding the life insurance proceeds and the beneficiaries remain confidential. This confidentiality protects the family’s financial affairs from public scrutiny and potential disputes.

Smooth Wealth Transfer

The establishment of an ILIT allows for a seamless transfer of wealth to beneficiaries. Upon the grantor’s passing, the trust assets, including the life insurance proceeds, can be distributed directly to the beneficiaries without the delays and expenses associated with probate. This enables beneficiaries to access their inheritance promptly, ensuring financial stability during a challenging time.


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