The Irrevocable Life Insurance Trust
is a way of "discounting" the estate tax through the use
of life insurance. Normally, life insurance death benefits are included
in the Net Taxable Estate (IRC 2042).
Irrevocable Life Insurance Trust (ILIT) is a method having one's
life insured with a life insurance policy while not having the death
benefits included in their Net Taxable Estate. These trusts were
confirmed following the court case of Crummy vs. Commissioner, 397
F.2d 82 (9th Cir. 1968) as well as a number of following IRS Revenue
the ILIT is the owner of the policy. The insured person (or their
spouse, etc.) makes annual gifts to the Trustee of the ILIT who
purchases the policy and makes the periodic required premium payments.
The Trustee must be a "disinterested third party" at "arm's
length" and cannot be the insured, any family member, nor employee.
Normally, the premiums gifted to the Trustee would be taxable under
gift tax laws (the $10,000 exclusionary gift is not allowed where
the asset is one of future value, such as life insurance). With
a Crummey Power provison in the trust, the gifts are free of gift
taxes up to $10,000 per year per beneficiary of the ILIT. If one
had 3 beneficiaries, one could give, free of gift taxes, $30,000
per year for the Trustee to use for premiums. With each gift, the
Trustee must notify the beneficiaries, in writing, that a gift has
been made and that they have the right to intercept 5% or $5,000,
whichever is greater, of this gift. If they fail to act within a
specified period of time (usually 30 days), then the gift is retained
by the Trustee to pay the policy premium.
insured has no incidences of ownership over the policy. They cannot
change beneficiaries, borrow against policy cash reserves, nor pledge
the policy as collateral for a loan. The Trustee cannot be required
to purchase life insurance with the gift. Nor can the beneficiaries
be required to use the death benefits to retire the insured's estate
taxes. These are "rules of agency" which can cause the
ILIT to fail and the death benefits would be added to the insured's
Net Taxable Estate.
There are two classes of beneficiaries. If the policy pays a death
benefit on the death of the first spouse in a marriage, the Trustee
can invest the death benefits and pay the surviving spouse (the
income beneficiary) a pension for life. This would be taxable income
for income tax purposes. The second class are the principal beneficiaries.
Generally, this are the children who would receive the full death
benefit at the death of the surviving parent.
ILIT can be a very wise estate planning tool. For the expense of
gifts to pay the premiums, the insured's estate does not have to
pay a much larger tax at death. This, in effect, discounts the estate
tax. Instead of having to pay a $1,000,000 estate tax obligation,
the insured paid far less in gifts during their lifetime to pay
the policy premiums. It is also an excellent vehicle for passing
wealth to heirs, because the Trustee could monitor and limit how
the wealth is distributed to them.
An existing life insurance policy can be irrevocably given to an
ILIT, but the arrangement will not be recognized by the IRS for
3 years. This is the same generasl "look back" rule which
is used for gifts in "view of imminent death." An ILIT
must be registered with the IRS and have its own EIN number. The
Trustee must submit an IRS SS-4 form and Form 56 along with a copy
of the ILIT instrument to the IRS or the arrangement will not be
recognized by them.