How to Use an ILIT to Keep Life Insurance Proceeds Out of Your Estate
Today we are taking a close look at a very important estate planning tool: the Irrevocable Life Insurance Trust. While the Irrevocable Life Insurance Trust is a very simple Trust with a very simple purpose, it is also very simple to screw it up—especially if you DIY it. Let’s take a closer look at the Irrevocable Life Insurance Trust and best practices so it doesn’t become a headache for your estate.
Set up the Irrevocable Life Insurance Trust First
The first step in using an Irrevocable Life Insurance Trust, or ILIT (pronounced like the word eyelet), is to create the life insurance Trust. This is because the Trust has to own the life insurance policy.
So, step one is to establish the Trust. This Trust is Irrevocable— meaning once it’s established it can’t be changed. Another sticky point of an ILIT is that you, the Trust maker, cannot be the Trustee. So, be sure the person you name as the Trustee is responsible and trustworthy. Many people opt to use a professional service, such as an accounting firm or their attorney as their trustee.
Once the Trust is established it can be funded. Remember that a Trust is like an empty box. Funding it is putting things inside that box. Also, remember that the only purpose of the ILIT is to hold a life insurance policy. So, the only thing going in the box is a life insurance policy. Nothing more than that.
The ILIT Pays for the Life Insurance Policy
If step one is to establish the Trust, step two is to fund it. And like we mentioned above, this Trust will only be funded by a life insurance policy.
It is very important that the Trust be the one to purchase the policy— not you, an individual.
In order to do this, each year a monetary gift is made to the Trust to purchase the life insurance or continue to pay the premiums. So, the initial cash gift is made to the Trust to purchase the life insurance policy. And each year thereafter an additional cash gift is made to the Trust to fund the cost of the policy premiums.
In order to avoid gift taxes, notices, called Crummey Letters, must be sent to each beneficiary of the ILIT.
Crummey letters
As mentioned above, a Crummey Letter, is a notice sent to each beneficiary of the Trust when there are funds added to pay for the policy or its premiums. This notice alerts the beneficiary that there are funds available in the Trust and they have a certain number of days to request their share of the funds be released to them.
The key here is that you do not want them to collect these funds. If they do, it ruins the whole purpose of the ILIT because once their portion is disbursed the Trust will not have the funds to pay the policy premium. This will likely result in the loss of the policy.
So, while they have the option to request their portion, they really should not do so. It’s one of those situations where taking a little bit now knocks you out of getting a lot later.
Cautions
As you can imagine, it’s pivotal to have responsible beneficiaries when setting up this type of a Trust. If you do not think your beneficiary can defer their need or desire for cash until the policy vests, than this may not be the best Trust for you—or they may not be the best beneficiary for this Trust.
Another concern is working with a policy that has been purchased prior to setting up the Trust. This process can be long and complicated. It’s always best to have the Trust purchase the policy. However, if you find yourself in a situation where you have a policy you want in an ILIT, it is imperative you work with a skilled attorney to ensure everything is done properly as you move forward.
Benefits
An ILIT is a wonderful tool to help individuals and families with a higher net worth avoid estate taxes and probate, and help them pass the largest possible legacy on to the future generations. It’s a great way to shelter and protect large amounts of cash from federal taxes. If this is something that concerns you, the professionals at Siedentopf Law would love the opportunity to help you create an estate plan that gives you peace of mind for the future.
Call us at (404) 736-6066 or visit our website to schedule a consultation.
