Because of the larger estate tax exclusion
of $5,000,000 per person (already $5,125,000 because of the cost of living
increase), many clients no longer need an Irrevocable Trust to own their life
insurance in order to avoid tax on the proceeds at death. However, an
Irrevocable Trust is still an important planning tool for those whose estates
already exceed the estate tax exclusion or for those whose estates increase in
value faster than anticipated.
We
previously discussed the basic concepts of an Irrevocable Life Insurance Trust
(ILIT), but today we want to focus on how policies are transferred to the
ILIT. There is an estate tax rule that
requires the inclusion in a decedent’s estate of life insurance transferred
within three years of death. Because of
this rule, the ideal planning technique is for Grantor to execute the ILIT and
then for the Trustee to apply for new insurance on the life of the ILIT’s
Grantor. If the Trust is the initial
owner and beneficiary of the life insurance policy, and the Grantor never had
any incidents of ownership in the policy, the three-year inclusion rule does
not apply.
If
there is existing insurance, a client will often set up an ILIT, have the trustee
apply for a new policy, and then terminate the old policy when the new policy
is issued with the Trust as the owner. This
protects the Grantor if the new insurance application is declined. There is usually no need to have twice the
insurance coverage, but you want to maintain the existing coverage until the
new policy is issued and effective.
Sometimes
there is a need for an ILIT, but the Grantor is unable to secure new insurance
coverage or the coverage is too expensive because of age or health issues. At these times you utilize the next best
strategy and transfer an existing policy to an ILIT, knowing the three year
inclusion rule applies. You need to
remember that the value of the policy at the time of the transfer is a gift. In addition, any amounts gifted to the ILIT
and later used for payment of premiums are gifts. If the policy transferred is a term policy, there
is probably little value other than the unused premiums for the policy year in
question. However, if the policy is an
existing permanent policy, there may be significant cash value requiring
consideration for gift tax purposes. The
Crummey rules require notice be given to Crummey beneficiaries so that the gift
can be considered a present gift and allow use of the annual gift exclusion. However, if the total of premiums and cash
value of transferred policies exceeds the total of Crummey beneficiaries times
$14,000, a portion of the gift will not qualify for the annual exclusion. Any gift in excess of the available annual
exclusions is considered a future gift and will use a portion of the Grantor’s
lifetime exclusion.
Planning
for policy transfers can be tricky and confusing and should be done with the
guidance of professionals qualified in both insurance and tax issues.
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