An Irrevocable Life Insurance Trust (“ILIT”) is a trust that has a life insurance policy. Generally, life insurance proceeds are included in your property for federal tax purposes. Depending on the size of an estate, there may be federal taxes due at death. However, if ILIT is properly established and operated, the insurance proceeds from the policy are not included in your property for federal tax purposes.
As the name suggests, ILIT is irrevocable and its terms cannot be changed once created. The ILIT will require a trustee, who must be another person who created the trust (the “Gender”) or the person who “closes” the Giver. The ILIT must also have designated beneficiaries in the trust, who are usually the children of the Grantor.
Once an ILIT is created, it must obtain a tax identification number and open an account to receive a “gift” from the Giver. Typically, these gifts are annual payments made to ILITs that are equal to or less than the amount allowed for annual gifts to any person, so as not to trigger federal gift tax issues. The “gift” is then used by the trustee to pay the premium due on the life insurance policy.
“Gifts” made by the Grantor must also meet other requirements to ensure that life insurance proceeds will not be subject to federal estate taxes. First, after the gift is made, the guardian must give written notice to the recipient (or the guardian of the minor recipient) and grant the recipient the right to collect the gift in lieu of paying the premium. The recipient usually has 30 days to choose to withdraw the prize amount. It is important to explain to beneficiaries that by withdrawing these funds, they may end up destroying more of their inheritance. Also, if the beneficiary withdraws money, then the premium cannot be paid and may cancel the insurance policy. At the end of the 30 day period, the trustee then uses the rewards to pay the insurance premiums.
After the Grant Giver dies, the ILIT, who is the beneficiary of the policy, will receive the death benefit. Insurance results can be:
· used to increase liquidity in plantations by purchasing plantation assets in cash;
· loaned to plantations to pay off tax obligations or obligations;
· held in trust for beneficiaries; or
· distributed in accordance with ILIT provisions.
In summary, the main benefits of ILIT are:
provide liquidity without requiring the sale of other assets;
· increase the size of the estate without increasing the land tax;
· allow transfers out of the estate with minimal or no gift tax consequences; and
can provide ongoing asset management under the terms of the trust.
There are several other points to consider when implementing ILIT. First, an ILIT is a taxable entity that must file its own tax returns separately each year. However, returns are generally simple and can be handled easily by an accountant. Second, the transfer of an existing life insurance policy to an ILIT may result in the policy proceeds being included in taxable property if the policyholder’s death occurs within three (3) years after the transfer. The recommended approach is for ILIT to acquire a new policy and then the three-year restriction will not apply.