Law Office of Eric Holk

Certified Specialist in Estate Planning, Trust & Probate Law
The State Bar of California Board of Legal Specialization

60 Garden Court, Ste. 205
Monterey, CA 93940
Phone: 831-622-8808
Fax: 831-655-3660

THE IRREVOCABLE LIFE INSURANCE TRUST

The irrevocable life insurance trust is a trust established during the lifetime of the insured for the purpose of owning a life insurance policy. The trustee is named as beneficiary of the policy, but the terms of the trust determine who will actually receive the policy proceeds. At the death of the insured, the policy proceeds are paid to the trust and are not included in the taxable estate of the insured (assuming all requirements have been met), since the trust, not the insured, owned the policy.

How is such a trust established?

Step 1 The insured creates a trust with an independent trustee during the insured's lifetime. Such a trust must be irrevocable, meaning it cannot be changed or terminated.

Step 2 The insured may either transfer an existing life insurance policy (or policies) to the trust* or sufficient cash for the Trustee to purchase a new policy.
* certain limitations apply--see below

Step 3 Transfers to irrevocable trusts are usually subject to gift tax and do not qualify for the $13,000 annual gift tax exclusion. However, if the ultimate beneficiaries of the trust are given a limited right of immediate withdrawal, the annual gift tax exclusion becomes available. If the named beneficiaries do not exercise their withdrawal rights within the specified time period, those withdrawal rights lapse. (A parent or legal guardian can represent a minor child beneficiary.)

Step 4 Assuming the withdrawal rights are not exercised, the Trustee uses the deposited funds to pay the life insurance premiums.

What happens at the death of the insured individual?

  1. The Trustee collects the policy proceeds from the life insurance company.
  2. If the estate of the insured person needs added cash to pay estate taxes or debts, the trustee can either :
    1. buy assets from the estate for cash, providing liquidity for the estate and allowing the assets to then pass to the beneficiaries of the trust (often the children of the insured); or
    2. lend cash to the Executor of the estate (or Trustee of the insured’s revocable living trust), to be repaid upon eventual sale of the estate (or trust) assets. The Executor of the estate (or Trustee) then uses the cash to pay estate taxes and debts.
  3. Assets in the trust can then be held or distributed according to the terms of the trust for the benefit of the insured's family or other named beneficiaries.

Irrevocable Life Insurance Trust

ADVANTAGES

If properly structured, the irrevocable life insurance trust can:

  • Increase the liquidity of the estate without requiring the forced sale of illiquid assets.
  • Increase the size of the estate without increasing the estate tax, putting more in the hands of the heirs and eliminating the IRS as an added "beneficiary" of the policy.
  • Allow for transfers out of the estate with minimal gift tax consequences.
  • Provide for ongoing management of assets under the terms of the trust.

RESTRICTIONS

  • The trust requires an independent trustee (not the insured and not someone in the immediate family), and it may be necessary to pay a reasonable fee to the trustee.
  • Annual notices must be sent to each trust beneficiary when funds are given to the trustee for the annual premium payments on the insurance policy.
  • The annual premium amount delivered to the trustee will use up some or all of the annual gift tax exclusion amount for gifts to the trust beneficiaries.
  • The trust must be irrevocable, meaning the terms of the trust cannot be changed or terminated. The insured cannot retain any rights, such as the right to replace the trustee or change beneficiaries, without taking the risk of having the policy proceeds subjected to estate tax.
  • A new policy may require a medical examination, plus the time spent in finding and applying for the proper policy.
  • Transfer of an existing policy may result in the policy proceeds being included in the taxable estate if death occurs within three years of the transfer. The recommended approach is to acquire a new policy.
  • Transfers to the trust may be subject to gift tax in some circumstances.

 

For more information on irrevocable life insurance trusts, contact an estate planning attorney.

 

60 Garden Court Suite 205
Monterey, CA 93940
ph: 831-622-8808
fax: 831-655-3660
office@trusts-etc.com

Information is copyrighted by Eric N. Holk, 2012.

No information on this website shall be construed as legal counsel.
If you need legal advice, please contact Mr. Holk or another qualified attorney.
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