Irrevocable Life Insurance Trust: A General Procedural Outline

August 31, 2017

As estate planning attorneys serving southeast Wisconsin, we work with our clients to create an Irrevocable Life Insurance Trust (ILIT) to prevent life insurance from inclusion in the client’s federal taxable estate at death. Moreover, we also create ILITs to help protect life insurance or insurance policies from a nursing home or other potential creditors.

An Irrevocable Life Insurance Trust (ILIT) is set up to allow Grantor to pay premiums on life insurance owned by the trust, without incurring a gift tax and without the life insurance policy being included as an asset owned by Grantor upon Grantor’s death.  This allows the life insurance policy, which is owned by the ILIT, to not incur estate tax upon the Grantor’s death.  This normally results in more funds being received by the beneficiaries since they will receive the life insurance estate tax free.

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An Irrevocable Life Insurance Trust: Only the Beginning

The creation of an ILIT is only the beginning of the ILIT estate planning process. The ILIT will receive gifted funds to pay for life insurance, while still allowing the use and advantages of the annual gift tax exclusion (currently $14,000 per person per year for 2017).

What Procedures Follow the Creation of an Irrevocable Life Insurance Trust?

The following is a brief explanation of the procedures that our clients and trustees normally follow. After an ILIT has been established and Funded with a Life Insurance Policy, our estate planning lawyers guide our clients and trustees through the following procedures:

1. Establish an ILIT Checking Account

The Irrevocable Life Insurance Trust needs a checking account to pay the life insurance premium and to receive funds from the Grantor. The trust name is on the account. The Trustee has the right to sign checks and have power over this account.  The trust EIN is used as the “tax ID number” for this account – not anyone’s social security number.

The Grantor is never a Trustee on an ILIT. The Grantor (the person who set up the trust and who’s life the policy is normally on) is not on this account as a signor, POA, Trustee or owner in anyway. It is not Grantor’s account.

2. Grantor Transfers Funds Every Year to the Trustee/Checking Account

The Grantor should not pay a premium directly on either a new or existing trust policy. All premiums should be paid by the Trustee from a trust-owned bank account as mentioned above. The Grantor’s gifts should be deposited into the trust checking account.

3. The Trustee Pays the Life Insurance Premium from the Trust Checking Account

The Trustee writes and signs a trust check from the trust checking account for the premium payment.

The Grantor must make the gift/transfer early enough to allow the trustee to mail out the 30-day Crummey notices. The trust must have the cash resources available to meet the beneficiary withdrawal rights for the 30-day period. Once the insurance policy has sufficient accessible cash value, then the 30-day waiting from grantor’s gift is not as important for some ILITs.

Therefore, we suggest that at least 60 days prior to the expected annual premium being due, Grantor transfer funds to the trust checking account.

4. Mailing of Crummey Notices

We strongly suggest that the Trustee mail the Crummey notices immediately upon the deposit being made by Grantor. We also strongly suggest that these notices be sent certified with a return receipt. It’s very important that the notices be marked and initialed by each beneficiary.

The Crummey notices so initialed by each beneficiary and the return receipts should be kept with the trust file permanently. If an IRS audit ever occurred, it would then be easy to prove that the Crummey notices were sent and received each year.  Remember, that any audit is most likely to occur after the death of Grantor.

5. Crummey Notices Briefly Explained

For tax purposes, in order to qualify for the annual gift tax exclusion, the ILIT beneficiaries must have a legal right to withdraw funds from the trust. Failure to follow the proper “Crummey” procedures will result in a taxable gift to the trust.

However, it is normally in the beneficiaries’ best interest to leave the money in the trust to pay the insurance premiums, so when the Grantor passes away, the insurance funds can pass to the beneficiaries’ estate tax free. To make this work, the gift must be considered for tax purposes to be a current or “present” gift to the beneficiaries. The Crummey right of withdrawal given to each beneficiary makes the gift a current gift to the beneficiary for tax purposes, thus allowing the use of the annual gift tax exclusion.

6. The Value of Crummey Powers and Notices ILIT

In order to qualify for the annual gift tax exclusion – currently $14,000.00 per person per year – there has to be an immediate gift to the beneficiaries for tax purposes.

Without the Crummey power (the right of the beneficiary to withdraw funds from the trust), the transfer to an irrevocable trust would not qualify for tax purposes as an immediate true gift to the beneficiaries. It would simply be a taxable gift to the trust. Giving the Crummey power right of withdrawal to each beneficiary results in gifts up to the annual gift tax exclusion amount to not count as taxable gifts. The gifts to the ILIT are treated as immediate gifts to the beneficiaries since they had the real legal right to withdraw the gifted funds for a 30-day period.

Why All of These Steps Are Necessary and Should Only be Followed with the Advice of an Attorney?

For federally taxable estates, it is not only crucial that the ILIT be initially set up and funded properly, but that the proper procedures are followed consistently. Wokwicz Law Offices has guided clients through the creation and funding of ILIT for decades, including ensuring that our clients understand the appropriate procedures to maintain an ILIT in good standing.

Let’s Discuss an ILIT and Your Needs

We discuss life insurance trusts with our clients, where appropriate, as part of the estate planning process to compliment clients’ Last Wills and Testaments, Revocable and Irrevocable Trusts, Transfer on Death Deeds and Powers of Attorney. We invite you to contact our office to set up an appointment.

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This article is intended as general legal information and not as legal advice to any particular client, nor is it intended as advice on any particular issue or matter. If you have any questions regarding the subject matter of this article, or wish to discuss how the subject matter of this article may apply to your situation, please contact us.