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Trusts 101

Irrevocable Life Insurance Trust

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An Irrevocable Life Insurance Trust is a trust which cannot be revoked or amended by the grantor which has a life insurance policy in it. The trust is both the owner and beneficiary of a life insurance policy.  An existing policy can be transferred to a trust that is established later, or by a policy can be purchased by a trust in the first instance.

A life insurance policy can get into the trust in one of two ways. It can be transferred to the trust or the trust can purchase the policy.

If an existing policy is transferred, the transfer must be complete and irrevocable. The person who sets up the trust (the Grantor) cannot keep any incidents of ownership in the policy -- including the right to change the terms of the trust or the identity of the beneficiary.

The Grantor cannot serve as trustee.

The Grantor is also prohibited from using the cash value in the life insurance policy, if there is any. That said, it would be ossible for an independent trustee of the trust to loan money to the Grantor.

The trust could be set up so the trustee has the power to change the identity of the beneficiary. Note that the trust has this right,  but the grantor doesn't. The grantor also no longer has a right to the cash value in the policy or the right to sell it such as in a Viatical Settlement or a Life Settlement.

Because of the irrevocable transfer, the life insurance policy is no longer part of the taxable estate of the grantor.

The transfer of an existing policy to the trust is subject to gift tax. The gift is valued on what is technically referred to as "interpolated terminal reserve value." This value is usually close to the cash surrender value, unless the insured is currently uninsurable or in poor health, in which case it can be higher.

With the transfer of an existing policy, if the grantor dies within three years of placing the policy in trust, the death benefit is still in the grantor's estate for estate tax purposes. With a policy that is purchased by a trust in the first instance, the value of the policy is out of the Grantor's estate immediately.

An interesting twist to be aware of when considering an Irrevocable Life Insurance Trust relates to annual contributions to the trust.

  • Any funds contributed to the trusts must be made in a manner that is independent of premium payments.
  • Each contribution must be subject to a right of withdrawal by the beneficiaries for a reasonable period of time. This is known as a "Crummey provision". A Crummey provision gives the trust beneficiaries the right to demand each year from a trust the lesser of:
    • The maximum gift tax annual exclusion; OR
    • The annual contribution to the trust.

The inclusion of a Crummey Provision makes gifts to a trust present rather than future interests and therefore eligible for the annual gift tax exclusion. The right to withdraw must be real and legally possible. Effective notice of the demand right must be given to the beneficiaries each year, as well as an adequate amount of time to exercise the withdrawal power after notice.

An insurance trust is generally part of a relatively sophisticated estate plan, and should not be set up without legal guidance.

Edited by: 
Jerry Simon Chasen, Esq. 
Chasen & Associates, P.A. 
Miami, Florida

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