Irrevocable Life Insurance Trust Overview

• Currently, the federal estate tax is not in effect for 2010 but will return with an
approximate $1 million federal exemption in 2011. A tax rate of 55% will be
applied to taxable estates over the exemption level. (5% surcharge over $10
million).
• Taxable Estate = Gross Estate – Deductions/Exclusions + Taxable Gifts –
Credits
• Gross estate comprises probate and non-probate assets, general powers of
appointment, special lifetime transfers, and Q-Tip Property.
• Deductions comprise ordinary and special (aka marital and charitable).
• Gifts in excess of the individual annual exclusion (13K in 2010) until $1 million
lifetime exemption is used up.
• Credits occur from the payment of gift taxes, foreign death taxes paid, taxes
paid on prior transfers.
• Life Insurance can be included in a decedent’s taxable estate if owner of life
insurance policy still maintains incidents of ownership (see below).
• One solution is to create a irrevocable life insurance trust or “ILIT.”
•ILIT is a type of trust, or legal entity, that owns the life insurance policies a
person transfers into the trust.
• Because trust owns the life insurance benefits, the benefits are not included in
decedent’s taxable estate allowing for greater flexibility in paying estate taxes.

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 Insurance Considerations
• Insurance will be considered part of your estate in some instances.
To avoid inclusion in estate do not name estate as beneficiary of life
insurance and eliminate incidents of ownership.
• Elements demonstrating incidents of ownership of insurance
include:
• if an individual has the right to change the beneficiary,
• If an individual can transfer ownership of the policy,
• If an individual can use the policy value as collateral for a loan, or
• If an individual has any other traditional rights of ownership.
• To avoid inclusion of life insurance in estate options:
• Properly transfer ownership to another individual following life
insurance company and IRS guidelines but lose control of the
policy,
• Create a irrevocable life insurance trust (ILIT) that removes life
insurance policy from estate and transfer policy into ILIT, or
• Have surviving spouse listed as beneficiary to use unlimited marital
deduction. Benefits from that policy will be incorporated into
surviving spouses estate upon their death or if spouse dies before
insured then insurance will be incorporated into insured’s estate.

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 ILIT Information
• An ILIT is created by the formation of an irrevocable trust. Irrevocable
means the trust terms cannot be rescinded, amended, or modified in any
way after it is created. Once the grantor contributes property to the trust, he
cannot later reclaim ownership of the property or change the terms of the
trust.
• ILIT can also be structured so that the trust will provide benefits to the
insured's surviving spouse without inclusion in the surviving spouse's gross
estate either.
• Generally, an ILIT is established with the opening of a new live insurance
policy.
• An existing policy may be transferred into an ILIT but will still be included in
the decedent’s estate for estate tax purposes until three years have passed
from the date of the transfer into the irrevocable life insurance trust. It
doesn’t mean the beneficiary won’t receive the money only it will be
considered part of the decedent’s taxable estate.
• An ILIT can be structured to include a clause that usually contain a fail-safe
provision if insured/transferor dies within the 3 years of the transfer of any
policy to the ILIT.

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 Creation of ILIT
• Creation generally includes these steps:
1. The need for the irrevocable trust is established.
2. Terms of the trust are designed including the establishment of
beneficiaries and the choosing of both initial and successor
trustees.
3. For a new policy, medical examination procedures should be
commenced. There is no need to draft a trust if clients are not
insurable. The insured should not sign anything at this point other
than in his or her capacity as insured (i.e., not as the owner or
applicant).
4. Attorney drafts insurance trust.
5. Client and trustee sign insurance trust. The trustee should apply
for employer identification number.
6. Depending on what type of policy dictates the next step – new
policy or a transfer of policy.

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 If a New Policy is Created
6(a) If a new policy is created:
A. Trustee applies for life insurance and signs application as
insurance owner.
B. If the insurance company requires a check with application,
the application should not be commenced until the following
three steps are completed:
i. the grantor makes initial gift to the insurance trust to
cover initial premium,
ii. a checking account is opened in the name of the trust,
and
iii. the trustee notifies beneficiaries that a gift is being made
to the trust and that they have rights of withdrawal.
C. The demand notice should be given and the period for
withdrawals (usually 30 days) allowed to lapse prior to
payment of any premiums to the insurance company.
D. The Trustee completes the application and pays initial
premium.

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 If a Policy is Transferred
6(b). Ownership of the policy can be assigned (transferred) to the
ILIT. This is done by signing an irrevocable assignment form
available from the insurance company or from the agent.
Proper completion of the form will indicate that the ILIT will be
the new owner and the beneficiary.
A. The following also needs to occur:
i. the grantor makes a gift to the insurance trust to cover
initial premium,
ii. a checking account is opened in the name of the trust,
and
iii. the trustee notifies beneficiaries that a gift is being
made to the trust and that they have rights of
withdrawal.
B. The demand notice should be given and the period for
withdrawals (usually 30 days) allowed to lapse prior to
payment of any premiums to the insurance company.
C. Trustee notifies insurance company of change in bank
account.

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 Benefits of Creating an ILIT
• The proceeds of your life insurance policy are removed from your
estate and become free of estate taxes.
• The trust does not pass through the public probate process.
• Beneficiaries can use trust proceeds to pay estate taxes.
• Proceeds held in the trust may be protected from the creditors of
the trust beneficiaries.
• If you are married, you can arrange for your spouse to receive
income from the trust during his or her lifetime.
• Since the insurance proceeds will be held in trust for the benefit of
your spouse instead of going directly to your spouse, the proceeds
can't be taxed in your spouse's estate either.
• Premium payments are made as annual gifts from insured to trust
potentially lowering taxable estate.

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 Concerns with ILITS
• Once the trust is set up, you can’t change its terms.
• Once you transfer a life insurance policy to the trust, you:
• give up control over that policy,
• can’t make loans or withdrawals of the cash value of that
policy, and
• can’t change its beneficiaries.
• Trustees and legal advisors must carefully handle gifts made to the
trust to prevent triggering gift taxes.
• Professional trustees usually charge annual administration fees
and may not agree to manage smaller trusts.
• The insured can not be the trustee of the trust but spouse and/or
children can be Trustees.
• Each year, after insured gifts money to ILIT to pay premiums, a
“Crummey” letter must be written to each beneficiary stating that a
gift has been made to the ILIT and the beneficiaries can withdraw it
if they want within a certain timeframe, usually 30 or 60 days. If
they don't exercise this right, the gift becomes a present interest
gift. This is because gifts must have a “present interest.”

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