Batson Nolan explains how an ILIT can possibly help avoid a heavy tax burden.
Irrevocable Life Insurance Trusts and Crummey Letters
Many clients are unaware that the value of their life insurance policies may be includable in the value of their estates at the time of their death. Due to the high estate tax exemptions currently, this inclusion by the IRS does not affect most individuals or families. However, for families with high wealth, the inclusion of a high value life insurance policy into their estates could push them over the taxable threshold, exposing their estate to a very heavy federal estate tax burden.
What is an Irrevocable Life Insurance Trust?
One estate planning tool that can be utilized to help avoid this problem is the use of an Irrevocable Life Insurance Trust (ILIT). These trust are specially created for the purpose of owning life insurance policies, so that the value of these policies are not included in one’s estate at the time of their death. An ILIT can be formed by transferring an existing life insurance policy into a trust, or by having the trust purchase a life insurance policy directly. There are two important points to note.
- First, in order to achieve the desired results—preventing the policy from being included in one’s estate—this trust must be irrevocable. This simply means that once you have funded the trust, you relinquish all rights of ownership or interest in the trust, and can no longer make changes to it.
- Second, unlike revocable living trust, you cannot serve as trustee of this trust. By serving as trustee, you would be considered to have “incidents of ownership,” which would result in the IRS deeming the trust assets to be “reachable” and thus includible in your estate. However, you can have a spouse or adult child serve as trustee of this ILIT.
Who are the Trust’s beneficiaries?
Generally, you will name the ILIT as the primary beneficiary of the life insurance policy. Thus, upon death, the proceeds from the life insurance policy will be paid into the trust and held in the trust for the benefit of the Trust’s beneficiaries.
Just like with all life insurance policies, premiums must be paid whether monthly or annually. Since the ILIT owns the life insurance policy, the trust will be the making the monthly or annual payments. As such, the grantor of the trust will place the funds for the premiums into the trust to make said payments. However, upon doing that, the named beneficiaries of the trust are deemed to be receiving a “gift.” In order for this contribution to qualify as a “tax free” gift and fall within the $15,000 gift tax exclusion, the contribution must qualify as a present gift to the beneficiary. According to the IRS, a present gift is one that beneficiary has a “present interest” in—meaning that the beneficiary has an unrestricted right to access said assets immediately. Hence, the need for the Crummey Letter.
The Crummey Letter is a letter that is sent to the beneficiaries of an irrevocable trust informing them of that a gift has been made to the trust, and that they have the immediate and unrestricted right to withdraw those assets. Additionally, the letter will provide for a certain time period in which the beneficiary can withdraw the contribution (generally 30 days). If the beneficiary fails to act on his ability to withdraw this contribution, then the option will lapse and the contribution will be used to pay the policy premium. This letter essentially changes what would be a future gift into a present gift by giving the beneficiary an immediate and present interest in the gift. Thus, the contribution (gift) will then qualify under the gift-tax exemption to the extent it is under $15,000.
- It is important to note that technically the beneficiaries could withdraw this amount. Obviously, the Grantor will hope that the beneficiaries will refrain from withdrawing the amount contributed as it could, and likely would, result in the policy premiums going unpaid, thus causing the policy to lapse.
- It is also important to note that beneficiaries must be informed of this right to withdraw these funds (referred to as exercising their “Crummey Power”), each time a contribution to the ILIT is made in order to qualify for the gift tax exclusion. Thus, this letter essentially becomes a form letter that could be sent several times a year to the beneficiaries.
The experienced attorneys at Batson Nolan routinely deal with the complexities of estate planning, and are ready and available to help you navigate your way through. Contact us today to find out more about an ILIT and Crummey letters and if they can benefit you.