Major Reasons to Plan Your Estate

Your contribution to the ILIT represents gifts which you cannot get back. The gifts are usually used to pay the premiums on one or more policies insuring your life and which are owned by the trust. Because you cannot reclaim the policies, or receive any benefit from the trust, it would be inappropriate to have the trust own policies whose cash values you had planned to use for retirement income.

Currently, you may gift up to $15,000 per year per donee (recipient) without any gift tax implications. This exclusion is only available to gifts of a present interest, which is something you may enjoy or use now, and gifts in trust generally do not qualify, as they are gifts of a future interest, or one that will be enjoyed or used later. You may exceed the $15,000 year limitation by filing a Federal gift tax return and using some of your eleven million plus estate tax exemption to exempt the lifetime gift. In other words, the amounts you give that exceed the $15,000 are simply subtracted from the eleven million plus you can give at death.

To avoid this limitation, your ILIT should provide that each lifetime beneficiary (who must also be beneficiary or contingent beneficiary at your death) has the right to withdraw his or her proportionate share of the contribution for a limited period of time after each contribution is made.

Usually the trust agreement provides that, after a contribution is made, each beneficiary will be notified of their right of withdrawal. After the expiration of the withdrawal period (usually not less than 30 days), the trustee may use the contribution to pay the premium on a life insurance policy.

The IRS has approved the ILIT concept when all the technical requirements are met, but the IRS is notorious for challenging ILITs when the requirements are not met. Even the order in which the documents are signed is critical.

Existing policies may be transferred to your ILIT, but the death proceeds will be drawn back into your taxable estate if you die within three years of completing this gift. Also, the transfer of existing policies may trigger a taxable event. If you are insurable, it is sometimes advisable to consider a new policy.

The trustee receives the death benefit upon your death. These proceeds may be distributed to your family, held in trust, or used to purchase assets from your estate or from your revocable living trust. This last option would be important if your estate had insufficient liquid assets to pay estate taxes.

The tax on your estate is due nine months after the date of death. Those with large estates often do not have sufficient cash or other assets which could be easily converted to cash within the nine month time frame. The need to pay estate taxes has caused many a farm, family business, or major real estate holding to be sold at discounted prices to pay the estate tax.

Life insurance may provide the money needed to pay the estate tax, and by having the policy purchased and held in an ILIT, the proceeds may be used to provide the needed liquidity for your estate and yet not be subject to estate tax on your death.

Married couples may wish to consider using a “second-to-die” policy which pays the death benefit only after both spouses are deceased. That is usually the exact time that the proceeds are needed to pay the estate taxes. Because no death benefit is paid on the first death, the premium is much lower than purchasing a policy which insures just one life.

Often clients try to accomplish similar results to the ILIT by having, say, their two children own the policy equally. Many problems may arise under such an arrangement. A child may predecease the parent; the policy may be attached and liquidated by a child’s creditors; the policy could be considered as the child’s property in the event of a divorce; one child may refuse to pay the premiums or may wish to borrow the cash value. The outright gift of a policy makes no provisions for your children or grandchildren other than payment of proceeds. For example, you may want to provide that the proceeds be made payable to their Inheritance Protection Trusts. These and other issues may be addressed in a properly drafted ILIT.