An estate plan can contain various elements, including an irrevocable life insurance trust. Depending on your situation, this type of estate planning mechanism may or may not be right for you. An estate planning lawyer at Kramer, Green, Zuckerman, Greene & Buchsbaum, P.A. can evaluate your situation, present the full range of your options, and help you make the best choices for you and your family.
The general purpose of purchasing a life insurance policy is to provide financial security for your surviving loved ones following your death. Generally, life insurance proceeds are not subject to income taxes. However, in certain situations, life insurance proceeds, when combined with other estate assets, may reach a point at which they are subject to estate tax. Although the current estate and gift tax limit is very high – $12.92 million in 2023 – that limit is scheduled to be cut by 50 percent on January 1, 2016 (adjusted for inflation).
It may seem easier to transfer ownership of life insurance policies to the beneficiaries before your death to avoid estate taxes. However, under 26 U.S. Code § 2035, individuals who own or have “incidents of ownership” on an existing life insurance policy three years before their deaths will still have the proceeds of the life insurance policy included in their estates.
As a result, you might consider creating an irrevocable life insurance trust (ILIT) to ensure that your loved ones receive the full insurance policy proceeds without deductions for estate taxes.
Understanding the ILIT
An ILIT is a special trust that you create as the grantor or settlor to benefit specified persons. As part of the trust, you designate a trustee to administer the trust funds following your death. Once you create an ILIT, it is irrevocable, meaning you cannot change or rescind it, with a few narrow exceptions. For instance, the IRS permits individuals to modify an ILIT by creating a new ILIT with different provisions and assigning the life insurance policy to the newly formed ILIT. The assignment of the life insurance policy to the new ILIT is not a taxable event as far as the IRS is concerned, so long as the settlor is the same and continues to be responsible for any income tax on the trust income.
You cannot recoup any funds you contributed to the trust or borrow against the life insurance policy. In addition, once you have transferred ownership of the life insurance policy to the ILIT, you cannot reclaim it. However, if appropriately drafted, an irrevocable life insurance trust can avoid estate and gift tax liability for its beneficiaries.
You may not serve as trustee of the ILIT. If you serve as trustee, you retain “incidents of ownership” of the irrevocable life insurance trust, which defeats the ability to avoid taxation. Likewise, beneficiaries should not serve as trustees. Generally, trustees should be corporate trustees, professional advisors, or family members who are not beneficiaries of the trust.
Additional Reasons to Form an ILIT
Aside from estate and gift tax concerns, other reasons may make an ILIT an attractive option. For example, irrevocable trust assets are protected from your creditors and those of the beneficiaries of your trust. Since an irrevocable life insurance trust is irrevocable and you no longer retain ownership of the trust assets, your creditors cannot reach the trust assets. Likewise, since the trust assets are unavailable to the beneficiaries until the trust terms are satisfied, they are also unavailable to the beneficiaries’ creditors.
Setting Up an Irrevocable Life Insurance Trust
You must take several steps to set up an ILIT, as follows:
- Undergo a medical examination to ensure that you are insurable;
- Choose initial and successor trustees;
- You and the trustee will sign an insurance trust drafted by your attorney;
- The trustee applies for an employer identification number (EIN);
- Make an initial gift to the trust to cover the first premium payment;
- Open a checking account in the name of the trust;
- Notify beneficiaries of the trust and their withdrawal rights;
- The trustee may be able to apply for the life insurance policy directly as the policy owner on your behalf and pay the first premium, which alleviates the necessity of a transfer of ownership.
Disposition of the Insurance Policy Proceeds Upon Death
Upon your death, the insurance policy proceeds will pay to the ILIT. The trustee will then administer the policy proceeds, which belong to the ILIT, according to the trust terms. Finally, the trustee will distribute the trust assets to the beneficiaries you chose when you created the ILIT.
The trust structure is flexible and can vary widely according to your family’s needs. For example, you can structure the trust so that your surviving spouse receives income from the trust during their lifetime. Trust proceeds might exclusively go to children from your previous relationship. If your children are very young, have substance abuse problems, or are financially irresponsible, you can delay or stagger payment of the trust proceeds or even place conditions on their payout.
Contact Our Office Today for Your Estate Planning Needs
At Kramer, Green, Zuckerman, Greene & Buchsbaum, P.A., an estate planning attorney can provide a full range of estate planning services, including creating an irrevocable life insurance trust. In addition, if you lose a loved one, we are here to assist you with all estate, probate, or trust administration needs.
We can guide your family through the complicated legal landscape of estate planning law as quickly and efficiently as possible. Call us at (954) 966-2112 or learn more about the legal services we can offer you online. Please schedule an appointment to talk to us about your legal needs immediately.