ILIT - The Irrevocable Life Insurance Trust & Their Benefits

Have you ever heard of and ILIT? Have you ever heard financial professionals talk about them? Here are some interesting facts about them, especially if your estate has significant value.

Within an estate plan, life insurance can be used to:
• Pay estate taxes
• equalize the estate between heirs
• Fund state death taxes
• Fund business continuation plans, such as buy-sell agreements
• Provide funds for charitable bequests
People who need large amounts of life insurance need to be aware of the considerable estate tax advantages of an ILIT – an Irrevocable life Insurance Trust (1)
.
What is an Irrevocable Life Insurance Trust (ILIT)?
• an Irrevocable life Insurance Trust or an ILIT (also known as a “Crummey Trust”) is a planning tool used to keep life insurance proceeds outside of the taxable estate.
• The trust has its own Federal ID.
• The trust is the applicant, the owner and the beneficiary of the life insurance contract (2)
• The grantor(s) (insured) has no incidence of ownership in the life insurance contract.

The primary objectives of the ILIT strategy include:
• Remove the life insurance from the gross estate while still providing benefits to the surviving spouse and heirs
• Take advantage of the $12,000 ($24,000 for married couples) annual gift tax exclusion (year 2007)
• Use tax-free death benefits to provide liquidity to the estate through the purchase of assets from the estate or loans to the estate

How does an ILIT work?

The ILIT can be used as part of the overall estate plan. For example, Tom and Anne are married. as part of their estate plan, they have living trusts taking advantage of each of their estate tax unified credit amount ($2 million for the year 2007). In addition to the living trusts, Tom has an ILIT funded with a life insurance insuring him. The ILIT is the owner and beneficiary of the life insurance. To pay the life insurance premiums, Tom utilizes the annual gift tax exclusion and gifts $12,000 a year into the ILIT. let’s take a look at the flow of their estate upon Tom’s death (assuming Tom dies first):

Living Trust with Irrevocable Life Insurance

Planning considerations of implementing an ILIT
• The grantor (insured) cannot act directly or indirectly as the trustee of the ILIT.
• The ILIT cannot be changed or amended.
• The grantor (insured) cannot directly reach trust property (for example, cash values) during his or her lifetime(3)
• The life insurance contract must allow for Third party ownership (Trust ownership) (4)
• To avoid the three-year look back rule (see next bullet), the Trust (trustee) should be the original applicant and owner the life insurance contract (the trust should be in existence prior to the purchase of the life insurance contract).
• When transferring existing life insurance to an ILIT, the grantor (insured) must survive at least three years from the date of transfer of the life insurance to the trust. Otherwise, the insurance proceeds will be included in the grantor’s estate. This three-year rule can be avoided by having the ILIT apply for the life insurance as the initial owner.
• gift of existing life insurance is a gift tax event (5)
• gifts of premiums are gift tax events (gift taxes may be owed for premiums paid over the annual exclusion amount)(6)
• If trust provisions allow, additional policies may be added to an existing ILIT.
• a trust is a legal document and the trustee must act in accordance with the terms of the trust.

In summary, funding an ILIT is important because:
• It increases substantially in size upon the grantor (insured’s) death – generally, both federal income and estate tax free.
• It can usually be funded with gifts qualifying for the $12,000 /$24,000 gift tax annual exclusion per beneficiary.
• The cash value of permanent life insurance permits funding flexibility since the cash values can be used to pay the premiums after a period of years; and the insurance proceeds can eventually be used to provide liquidity to help pay the grantor's estate taxes.

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I do not give Legal advice, The information given here reflects my understanding of Current Laws and Regulations. This Strategy may not be appropriate for all. You should always consult your Legal, Tax, or Estate Planning Advisor(s) on your specific situation, Including a creation of an ILIT.

(1) For year 2009, estates valued over $3.5 million (including life insurance owned by the individual or the estate) are potentially subject to estate tax.
(2) Typical wording for the application is: “The Anne and Tom Smith Irrevocable Life Insurance Trust dated august 15, 2007, Bank, trustee.”
(3) The trustee can be given the right to use cash values for the benefit of the grantor/insured’s spouse and children during the grantor/insured’s life. also, the trust itself can state that certain individuals have the power to appoint the trust property back to the grantor/insured.
(4) Please check availability of third-party ownership on individual Insurance products.
(5) The amount of gift at transfer from one owner to another depends on the stage of the life insurance certificate. For new life insurance certificates, the gift tax value is the cost (net premiums paid); for existing life insurance certificates, the gift tax value is the “interpolated terminal reserve” plus any unearned premiums paid on the date of death less any policy loans.
(6) gifts to an ILIT for paying premiums on life insurance owned by the ILIT is not in itself a “present gift.” Providing an annual ”Crummey letter” to each beneficiary is what qualifies the gift as a “present interest” gift. a “Crummey letter” is sent each year to the ILIT beneficiaries stating their right to withdraw the gift within a certain amount of time, usually 30 to 60 days. If the beneficiaries do not exercise this right, the gift becomes a completed present interest gift and will qualify for the annual gift exclusion. For 2009, the annual gift exclusion (the amount one can gift without incurring gift taxes) is $13,000 per individual; $26,000 for married couples.