Irrevocable Life Insurance Trust ("ILIT")
Since life insurance is subject to estate tax, the primary
advantage of the ILIT is the complete removal of the policy
proceeds from the gross estate of both the insured and his
or her spouse.
An ILIT is a trust created to (i) hold
ownership of an insurance policy or policies and (ii) receive
the proceeds for the benefit of surviving family members.
Life insurance is an asset which can be easily utilized for
estate planning. There are a variety of types of life insurance
policies, such as universal, whole life, group term, and second-to-die.
If you are interested in purchasing life insurance, or if
you already own an existing life insurance policy, significant
tax benefits can be realized by creating an ILIT.
Life insurance serves very limited
lifetime purposes, so that an ILIT can be a valuable estate
planning tool in eliminating the life insurance proceeds from
estate tax.
EXAMPLE
A husband and wife have a $2 million
estate, which includes $500,000 of whole life insurance on
the husband’s life. The couple wants the surviving spouse
to receive the benefit of the entire estate and desires the
estate to be distributed to their children on the death of
the surviving spouse. Even with the use of the marital deduction
and a credit shelter trust, the federal estate tax payable
upon the second spouse’s death would be $320,000.
Significant federal estate tax savings
would be realized if the couple not only utilized the marital
deduction and a credit shelter trust, but also created an
irrevocable trust to hold the $500,000 life insurance policy
on the husband’s life. The federal estate tax payable, assuming
that the irrevocable life insurance trust was created and
funded at least three years prior to the insured’s death,
would be $114,000. A federal estate tax savings of $206,000
would be realized ($320,00 — $114,000).
The typical ILIT provides that when
the insured spouse dies, the surviving spouse will receive
all of the income generated by the reinvestment of the policy
proceeds.
Generally the trustee will have the
right to invade the investment principal for the surviving
spouse’s support, maintenance, medical care, and best interests.
Upon the surviving spouse’s subsequent
death, the trust will continue for the benefit of, or the
principal will be distributed to, the children or to other
designated recipients.
Two predominant planning issues center
around the creation of the ILIT. First, there
is a possibility of gift tax consequences, depending on the
cash surrender value of the policy. Generally, that value
is relatively low, so that a gift tax does not apply. Second,
the trust is considered irrevocable and cannot be
amended by the insured, even if family or personal circumstances
change in the future. Techniques recognized by the Internal
Revenue Service are available to eliminate or alleviate this
potential problem. For example, an “amendor” provision can
be added so that the amendor has the ability to amend the
terms of the trust under certain circumstances.
“SECOND-TO-DIE” LIFE INSURANCE
A life insurance policy on the lives of both spouses and which
does not mature until the death of the second spouse is referred
to as a second-to-die policy and is significantly less expensive
than a life insurance policy on the life of only one spouse.
A second-to-die policy is beneficial for those couples who
feel that their non-life insurance investment assets will
be sufficient to provide the surviving spouse with adequate
income and/or principal to sustain the surviving spouse so
that the income to be generated by the proceeds of the life
insurance are not needed by the surviving spouse; and/or desire
to pass their entire estate to their children and/or grandchildren.
Such a policy can in effect pay the estate taxes upon the
death of the surviving spouse by establishing an ILIT which
would acquire the second-to-die policy in an amount equal
to the anticipated estate taxes that will be due. In effect,
the policy proceeds pay the estate tax liability.
CONCLUSION
Regardless of the type
of life insurance policy, the beneficiary of the ILIT is able
to possess a broad interest in both the principal and income
of the trust (e.g., life insurance proceeds) after the insured’s
death. The ILIT may provide other advantages associated with
the use of trusts, including estate liquidity upon the death
of the insured; protection of the beneficiaries from creditors;
and independent investment management of the proceeds.
