Understanding Irrevocable Life Insurance Trusts

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1 Understanding Irrevocable Life Insurance Trusts

2 Understanding Irrevocable Life Insurance Trusts DISCUSSION TOPICS What is an Irrevocable Life Insurance Trust? How Does an Irrevocable Life Insurance Trust Work? What are the Benefits of an Irrevocable Life Insurance Trust? INVEST Trust Services The Irrevocable Life Insurance Trust cannot be changed or modified in any way after it is created. What is an Irrevocable Life Insurance Trust? An Irrevocable Life Insurance Trust (or ILIT ) is a special use irrevocable trust that is designed to shelter life insurance proceeds from taxation at the time of your death. Life insurance is a powerful tool for estate and financial planning. An ILIT can be a very powerful estate planning tool if structured properly, and used in the right situations. Life insurance proceeds receive preferential Federal Income Tax treatment at the time of your death. Insurance death benefit payments are income tax free to the policy s beneficiaries. However, life insurance is included in your estate if you are the owner (legally called the Incidents of Ownership ) of the life insurance policy and the proceeds are taxed under federal estate tax laws. To avoid federal estate taxation on the value of the insurance policy you can create an ILIT to hold one or more life insurance policies that you own. An ILIT can be designed to have many of the same features of a Revocable Trust; and it can add in additional asset protection provisions and language to keep the Trust in existence for the benefit of future generations. The Irrevocable Life Insurance Trust, like other irrevocable trusts, cannot be changed or modified in any way after it is created. Once you contribute property, or dollars, into the Trust, you cannot later reclaim the property or insurance policies; nor can you change the beneficiary of the policies. The Trust itself will be the beneficiary of the policy.

3 How Does an Irrevocable Life Insurance Trust Work? The following are suggested procedures to establish an Irrevocable Life Insurance Trust for the purchase and ownership of life insurance policies: First discuss with a qualified estate planning attorney the need for the trust. The Trustee, on behalf of the Trust, applies for the life insurance policy and signs the application as the owner of the policy. The attorney will incorporate the terms of the trust in the Trust Agreement; including the establishment of the Trust beneficiaries both initial and future generations. A medical examination needs to be performed. There is no need to draft the Trust if you are not insurable. The Trustee of the Trust will accept the administrative duties of the Trust by signing the Trust Agreement. The Trustee will apply for a Federal Tax Identification Number for the Trust. The Trustee, on behalf of the Trust, applies for the life insurance policy and signs the application as the owner of the policy. You make a contribution of cash to the Trust. This is considered a gift on your part to the beneficiaries of the Trust. The beneficiaries are notified (by a Crummey Letter or Demand Right Notice ) of your gift and have a right to withdraw the gift. (Annual premium payments for the policy will require you to make annual gift contributions well in advance of when the premium is due in order for the Trustee to send Crummey notification letters; and to allow the beneficiaries time to waive their right of withdrawal). If the beneficiaries do not elect to withdraw the gift, the Trustee will complete the insurance application and the Trustee will pay the initial premium.

4 If you already have a life insurance policy, the ownership of the policy can be assigned (transferred) to the ILIT. This is done by signing an irrevocable assignment form available from the insurance company. Proper completion of the form will indicate that the ILIT will be the new owner and the beneficiary of insurance death proceeds. However, if you die within three years of the date from which the policy was transferred, WHITETR@pcsb.org the life insurance proceeds will be included in your estate for federal estate tax purposes. This does not mean that the Trust will not receive the death benefits; it merely means that your estate will have to report the proceeds as being part of your estate when computing your federal estate tax liability. For your spouse s protection, the ILIT should usually contain a fail-safe clause, providing that if you die within three years after the transfer of any policy to the ILIT, then the proceeds of such policies will be held separately under the ILIT and be administered for your surviving spouse in a way that will qualify for the federal estate tax marital deduction. This arrangement will render those proceeds tax free if you die within three years and if you are survived by your spouse. The Trust itself must be established in states that have repealed the rule against perpetuities. The trade-off is that whatever is left of those proceeds will then be included in the estate of your surviving spouse. If you die after the crucial three-year time period, the fail-safe clause would not apply and the entire Trust would provide for the Trust s named beneficiaries. The three-year time period concern can be completely avoided if the life insurance policy is purchased at the outset by the Trustee of the ILIT. This way there is no policy transfer, so no three-year period to worry about. You can also take the ILIT one step further and set it up as a Dynasty Trust (see Dynasty Trust brochure) or a Generation Skipping Trust (see Generation Skipping Trust brochure) for the benefit of your children and future generations. You cannot serve as Trustee for your ILIT. However, INVEST Trust Services is highly experienced in the administration of ILITs and will be happy to serve as your Corporate Trustee.

5 What are the Benefits of an ILIT? While the primary benefit of an Irrevocable Life Insurance Trust is to keep the life insurance death benefit proceeds out of your federal estate tax liability, it can also have a number of other purposes and benefits. Below are four reasons why you might consider an ILIT. 1. No Loss of Control over Income-Producing Assets: An ILIT is an attractive alternative to other estate planning strategies that involve transferring substantial amounts of income producing assets out of your estate. Many irrevocable trust arrangements (i.e. Charitable Lead Trusts) may involve the transfer of valuable income producing or business assets that you may be hesitant to transfer out of your control. Yet, transferring a life insurance policy comes more easily; while the policy s premiums must be paid, the proceeds are only payable to beneficiaries upon your death. 2. Liquidity Creation: An ILIT that is structured properly provides liquidity. If your estate is laden with illiquid assets (i.e. real estate), an ILIT can be essential in order to pay a large estate tax bill without selling off assets. An ILIT can also provide funds necessary to pay your last debts or liquidity to fund a business Buy-Sell arrangement. An ILIT is an attractive alternative to other estate planning strategies that involve transferring substantial amounts of income producing assets out of your estate. 3. Leveraging the Generation-Skipping Transfer Tax (GSTT) Exemption: An ILIT can be used to leverage the insured s GSTT exemption. Whenever you would like to give to your grandchildren or to individuals removed by 2 or more generations, the IRS imposes a second layer of tax called the GST tax. However, a $1 million exemption exists to which transfers to a trust can be allocated at the time of such transfer. If the amounts transferred to the Trust appreciate, the ratio of assets exempt from GSTT to non-exempt assets will remain constant. As a result, if the entire transfer to the ILIT is allocated to the GSTT exemption, all GSTT tax can be eliminated at the final distribution, even if the Trust enjoys considerable income over the years. 4. Protecting Beneficiaries from Creditors: You can also protect your children and grandchildren from future creditors by including a spendthrift provision in the Trust agreement and granting discretion to the Trustee in giving distributions to the beneficiaries. If the ILIT includes investments or cash that you don t have access to, the assets can be shielded from your creditors.

6 Individuals Best Suited for an Irrevocable Life Insurance Trust Those who expect some estate tax at the time death. Someone with a significantly younger spouse. Business owners with or without Buy-Sell agreements. Business owners whose business would decrease in value upon their death. Those interested in charitable giving as wealth placement. Those desiring to leave a gift of love to a former spouse in a second marriage situation. INVEST Trust Services offers a complete suite of trust services. INVEST Trust Services is a Trust Representative Office of National Advisors Trust Company, NATC. The Trust Company is one of the largest independent trust companies in the nation. It is governed by the Office of Thrift Supervision, ( OTS ), a bureau of the U.S. Treasury Department. The Trust Company is also a member of the Federal Deposit Insurance Corporation ( FDIC ). By law, the Trust Company segregates all trust account assets from the capital assets of the Trust Company, ensuring they are never subject to potential creditor claims against the Trust Company. The Trust Company has a professional team of experienced trust executives that will serve all of your trust needs. Please contact your Trust Relationship Manager at INVEST Trust Services for more information. This information is general in nature and should not be construed as tax or legal advice. INVEST Trust Services does not provide tax or legal advice. Please consult your tax and/or legal adviser for guidance on your particular situation. Personal Trust Services Revocable Trusts Charitable Trusts Irrevocable Life Insurance Trusts Special Needs Trusts Irrevocable Trust transfers from other Corporate Trustees Marital Deduction Trusts Credit Shelter Trusts Bill Payment Accounts Investment Management accounts Retirement Plan Services IRAs Custodian or Trustee Defined Benefit Plans 401(k) Daily Valuation Platform Defined Contribution Plans Roth 401(k) Distribution processing and 1099R filings Contribution processing INVEST Trust Services is provided by INVEST Financial Corporation (INVEST), member FINRA/SIPC. INVEST is not affiliated with NATC or FiPar. Products offered through INVEST are: Not FDIC or NCUA insured Not Bank or Credit Union Guaranteed May lose value including loss of principal. 11bi

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