What Advisors Should Know About Irrevocable Life Insurance Trusts


DEATH AND TAXES MAY BE certainties of life, however, just how much tax your household pays upon your death is still within your control to a specific degree.

Financial Advisor Industry’s Future

The federal estate tax exemption under existing law is $11.58 million for people and $23.16 million for married couples. With exemptions at the greatest they have ever been, many people don’t need to be concerned about federal estate taxes, with one glaring caveat.

The present law will sunset in 2025 and go back to the old law, resulting in the exemption being “generally cut in half,” says Ray Radigan, head of personal trust at TD Wealth. There is likewise the potential wrench with the results of Election 2020, which could affect estate tax exemption laws.

So to say there is no need for property defense would be an oversight on the part of lots of monetary consultants. Like insurance coverage, tax shelters can still be worth putting in place, even if tax laws alter in your customers’ favor.

One possession security method is an irreversible life insurance coverage trust or ILIT.

What Is an Irrevocable Life Insurance Coverage Trust?

“An irrevocable life insurance trust is a type of trust that is specifically developed to hold a life insurance coverage policy so the earnings of the policy prevent estate tax,” says Jason Field, a monetary consultant at Van Leeuwen & & Business. It is a form of living trust that can not be dissolved or revoked unless failure to pay premiums triggers the insurance plan held by the trust to lapse.

“The primary benefits of an ILIT are that it can provide instant liquidity to recipients, and those earnings are tax-free,” says Nick Hatfield, vice president and wealth consultant at EP Wealth Advisors. “Furthermore, the value of the ILIT is beyond the estate and exempt to taxable estate estimation.”

An essential function of an irrevocable trust is that it moves ownership of the life insurance policy from the insured to the trust. For this to work effectively, the insured can not own or control the insurance policy.

Instead, “the policy is bought with the ILIT as the owner and the beneficiary, and the grantor being the insured,” says Loreen Gilbert, CEO, and creator of WealthWise Financial Services. The insured also can not be the trustee of the trust. Generally, the trustee is a household member, with the insurance coverage premiums being paid through yearly gifting from the insured to the trust, she states.

If all goes as planned, upon the insured’s death, the ILIT will distribute the life insurance coverage proceeds tax-free to the recipients.

Radigan shows this with an example: Suppose your client has possessions worth $15 million and purchases a life insurance coverage policy that pays a $5 million death benefit to her children. When your customer dies, she would have a taxable estate of $20 million, which is 2020, would sustain about $3.3 million in federal estate taxes.

If that $5 million insurance coverage policy were owned by an ILIT instead of your client, the taxable estate would be $15 million, decreasing the federal estate taxes in 2020 to about $1.3 million.

“Simply put, this estate saved $2 million by simply having the ILIT own the $5 million life insurance coverage policy,” Radigan states.

But what if the estate tax exemption decreases prior to your client dies? If this occurs, no damage no nasty: “If the estate tax exemption goes down, and your customer has currently moneyed an ILIT, that possession is safe from estate taxes,” Gilbert says.

Those properties are likewise safe from your beneficiary’s creditors as long as they stay in the trust.

What Financial Advisors Need to Learn About ILITs

ILITs are not without their downsides, possibly the biggest being their complexity. The difficulty with ILITs is to structure them in a way that the annual contributions, which cover the insurance coverage premiums certify for the $15,000 present tax exclusion.

To do this, “lawyers will often include what is called a Crummey power when preparing an ILIT,” states Brian Bruggeman, vice president and director of financial planning at Baker Boyer Bank. The Crummey power permits the guaranteed to pay the trust for the premium on her insurance plan without reducing her lifetime gift tax exemption quantity, however, it also means recipients should comprehend the function of the ILIT so they do not unintentionally run afoul of any guidelines.

Also, whenever a contribution is made, Crummey letters must be sent to the recipients “letting them understand of the present to the trust and that they can withdraw the cash,” Gilbert says. If the beneficiaries then take the cash out, the insurance coverage could collapse.

This points to another downside, particularly that the insurance coverage premiums for the policy should continue to be paid up until death; otherwise, the policy might lapse, triggering the trust to dissolve, Field says.

Your customer must be dedicated to keeping the policy over a long period. “The cost of insurance coverage connected with a long-term life insurance coverage policy normally rises with time, so to keep the policy from lapsing, clients need to be able to fund the policy appropriately,” Bruggeman states.

And despite the fact that your client is the one paying the premiums, she will have no control over the life insurance policy, suggesting she can’t change or designate a beneficiary or boost or decrease the policy.

Age is another factor to consider.

“There is a three-year appearance back for existing insurance coverage that is provided into the ILIT, so the grantor should be alive for 3 years after the insurance coverage policy is offered to the ILIT for it to stay outside the estate,” Gilbert says. This does not look for a new policy developed in the ILIT and does not apply if the ILIT purchases the policy from the grantor.

Having the trust purchase the life insurance policy for the policy’s interpolated terminal reserve, a fancy way of stating the policy’s reasonable value can be one method to prevent both the three-year rule and minimize your customer’s lifetime taxable present exemption, Bruggeman states.

When to Use an ILIT

Given these intricacies and possible downsides, the question becomes are ILITs ever worth the effort? The answer is still certified is yes.

“Anybody with a net worth of more than $5 million, who has permanent life insurance coverage policies for a survivor benefit, need to think about an ILIT,” Gilbert states. The exception to this is if the insurance coverage is planned to supplement retirement earnings, in which case, it must not go into an ILIT.

Irrevocable trusts can also be ideal estate preparation tools for effective company owner. If most of your customer’s wealth is connected up in his/her business, there might not be adequate liquidity to pay estate taxes. This may require the beneficiaries to sell part of the business to cover the taxes, Bruggeman states.

An ILIT can be a practical service in such situations. Given that the death advantage is paid to the ILIT without an estate tax, the trust can disperse the death benefit straight-out to recipients, who can utilize the earnings to pay the estate taxes, Radigan states.

ILITs can likewise be used for clients who want to help their heirs with taxes due on inherited specific retirement accounts now that the stretch Individual Retirement Account, which permitted non-spousal recipients to stretch withdrawals of acquired assets over the recipient’s lifetime, is no longer an alternative, Hatfield states.

“In the end, an ILIT can be a very useful structure to save estate tax, however, consultants should beware and ensure that the trust is drafted and administered properly to take full advantage of the benefit and lessen any risk,” Radigan says.

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