November 13th, 2018

Advantages of an Irrevocable Life Insurance Trust (ILIT)

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Author: Micah A. Bonaviri

ILIT Family Sketch

As many are aware, in 2018 the federal estate tax exemption is currently $11.18 million, the Maryland estate tax exemption is $4 million (increasing to $5 million in 2019) and the D.C. estate tax exemption is $5.6 million while no estate tax is currently imposed in Virginia. Depending upon the circumstances, the applicable state exemption amount can often be reached quickly by life insurance death benefits that, while typically income-tax-free, are includable in your estate if you own the policy or have rights to it.

A properly drafted Irrevocable Life Insurance Trust (“ILIT”) provides a number of useful estate planning benefits. Perhaps the most common reason to use an ILIT is to remove the life insurance proceeds from both the grantor’s and the spouse’s taxable estate while allowing the proceeds to be available to meet the needs of the surviving spouse and descendants. However, it is important to ensure that the grantor does not retain any “incidents of ownership” over the policies that would cause the insurance proceeds to be included in the grantor’s estate. Accordingly, the ILIT is intended to be the owner and the beneficiary of the life insurance policy.

There are additional reasons why an ILIT may be useful:

  1. The life insurance proceeds held in an ILIT can provide liquidity to pay estate taxes, as well as other debts and expenses, by purchasing assets from the grantor’s estate or through a loan.
  2. The ILIT serves as a vehicle to manage and control life insurance proceeds. Assets held in an ILIT are generally protected from the creditors of a beneficiary because the ILIT can be designed to give the Trustee the discretionary power to make distributions. This is especially useful if the grantor has children who are minors or who otherwise need financial protection.
  3. The ILIT leverages the grantor’s generation skipping transfer (GST) tax exemption because the grantor’s GST tax exemption can be allocated to an ILIT holding a life insurance policy that may substantially increase in value. As a result, numerous generations may benefit from the trust assets free of federal estate and GST tax.
  4. A properly drafted ILIT avoids adverse gift tax consequences. Contributions, such as premium payments made to the Trust, are deemed to be gifts to the beneficiaries. In order to avoid adverse gift tax consequences, the trust must follow certain procedural requirements named after the famous “Crummey” tax case. To avoid adverse gift tax consequences, it is crucial that the Trustee, using a “Crummey” letter, notify the beneficiaries of the Trust of their right to withdraw a share of contributions for a thirty (30) day period. This procedure qualifies the transfer for the annual gift tax exclusion (currently $15,000 in 2018), avoiding the need in most cases to file a gift tax return with the resulting reduction of the federal exemption at death.

A properly drafted ILIT can accomplish many estate planning objectives. However, because of strict IRS guidelines, it is crucial that certain drafting and procedural requirements be followed to ensure that the beneficiaries realize the full benefits offered by the ILIT.

If you have any questions about this or other estate planning issues, please call 301-340-2020.