The Irrevocable Life Insurance Trust (ILIT) has been used by Estate Planners for many years. The advent of the unlimited Estate Tax Marital Deduction substantially increased the amount of property that can be passed free of Estate Tax to the surviving spouse.
If properly arranged, a married couple may transfer twice the amount of the Unified Credit Equivalent to family members without incurring any Federal Estate Tax liability. In larger Estates, proper planning can greatly reduce the Federal Estate Tax liability, but cannot completely eliminate such tax.
The ILIT is the best way to provide liquidity to pay the reduced Estate Taxes, especially upon the death of the surviving spouse.
Generally, the ILIT is an irrevocable Trust created during the lifetime of the Creator of the Trust, called the Grantor. Upon creation, the Trustee purchases an insurance policy on the life of the Grantor. Alternatively, an ILIT may own a joint and survivor policy insuring the lives of multiple Grantors (i.e., husband and wife).
The Grantors may then make annual gifts to the Trustee of the Trust on behalf of the Trust beneficiaries. The Trustee, in turn, may use such gifted funds to pay annual policy premiums.
The ILIT may also contain specific provisions intended to optimize the tax benefits of the Trust.
Such provisions include the use of a beneficiary’s demand withdrawal right, or “Crummey” power, so that most, if not all, of the annual premium payments do not create Federal Gift Tax consequences. In addition, an ILIT owning a policy on one spouse’s life may contain a provision giving the Grantor’s spouse a Special Power of Appointment to distribute the life insurance proceeds, following the insured Grantor’s death, to specified family members during the Grantor’s spouse’s lifetime.
In larger Estates, the ILIT may be used in the format of a “Dynasty Trust” — one scheduled to continue for several generations into the future.
Where a Grantor transfers an existing life insurance policy on his or her life to the ILIT, he or she must survive three (3) years from the date of such transfer to ensure that the policy is not taxable in his or her Estate. With an ILIT, the Grantor can ensure a source of financial support for his or her spouse without causing the inclusion of the insurance proceeds in either spouse’s Taxable Estate.
Also, an ILIT can be a source of liquidity to both Estates without causing a Federal Estate Tax liability, by giving the Trustee the power to make loans to the Estates of the respective spouses for these purposes, or to purchase assets from their Estates at finally determined Estate Tax values.
The ILIT also allows the Grantor to avoid Gift Tax consequences on all but extremely large life insurance policies. In addition, the Grantor can provide the flexibility to meet unforeseen major changes in his or her family’s situation by utilizing specially tailored Trust provisions capable of anticipating changed circumstances.
An increasingly common and advantageous technique is to combine an ILIT with a Charitable Remainder Trust. This is known as the “Wealth Replacement Technique.” The Trusts are coordinated so that the income interest retained by the Donor from the Charitable Remainder Trust may be used to pay insurance policy premiums by gifting such amounts to the ILIT.
This technique allows the Grantor to reduce his or her Taxable Estate by means of the charitable deduction from the Charitable Remainder Trust, provide liquidity for the payment of Estate Taxes through the ILIT, and maintain the value of the family’s inheritance.