The Estate Planning lawyers at the Elder & Disability Law Center provide comprehensive estate planning advice and legal services to individuals and families in the Washington, D.C., area, Maryland, and Virginia. Please contact us for a consultation an irrevocable life insurance trust or any other estate planning option.
One method of reducing the impact of estate taxes on the value of your estate is by purchasing a life insurance policy with a death benefit equal to the amount of taxes your estate will owe at your death. The policy is then placed into an irrevocable life insurance trust (ILIT). However, a few things should be kept in mind when creating an ILIT.
First, do not own the policy on your own life or the value of the policy will be included in your estate, increasing the amount of taxes you are trying to avoid. In order to avoid this problem, create an irrevocable life insurance trust (ILIT). After creating and funding the trust, the independent trustee can then buy the insurance on your life.
If you already have an insurance policy, you can gift the policy to the trust, making the trust the new owner of the policy. However, if you die within three years of transferring an existing insurance policy into the trust, the IRS will include the death benefit in your estate. The transfer is considered to have been done in "contemplation of death" solely for tax purposes, which is not allowed.
Second, bear in mind that the ILIT is irrevocable and contributions to the trust cannot be undone. In addition, you cannot be the trustee of the trust.
Third, if you transfer an existing policy to the trust that has any cash value, it is considered a gift. If the policy has a high cash value (over $12,000), gifting the policy to the trust could result in a gift tax.
Second-to-Die Policies Are a Great Estate Tax Planning Tool
Your Estate Planning attorney may suggest that you and your spouse purchase a second-to-die life insurance policy for your ILIT. Second-to-die policies insure the lives of two people, generally a husband and a wife. The benefit does not pay out until the second person on the policy dies. A second-to-die policy makes the most of the IRS's theory of taxing on the spouse who dies second. A U.S. citizen can leave all of his/her assets to his/her surviving spouse who is also a U.S. citizen without estate tax consequences through the unlimited marital deduction. Thus, there is no need to have a policy within the ILIT to use to pay estate taxes until the second spouse dies. Purchasing a second-to-die policy is a simple way to ensure that no matter which spouse dies first, the estate taxes will be taken care of.
Funding the ILIT
Unless you put a very large amount of money in the ILIT, you will need to continue funding the ILIT in order to pay the premiums on the life insurance policy. Any money you put into a trust is seen as a future gift for the beneficiaries, which means it is subject to the gift tax. However, the Crummey power, from the 1968 case Crummey v. Commissioner, allows you to make a present gift and, therefore, utilize the gift tax exemption.
The Crummey power is the power of the trust beneficiaries to withdraw newly deposited money from the trust. The trustee writes a letter, a Crummey letter, to the beneficiaries, notifying them that a deposit has been made into the trust. The beneficiaries then have a limited amount of time (e.g. 30 days) to express in writing whether or not they would like to withdraw the money from the trust. Your attorney can help you draft a correct Crummey letter to notify your beneficiaries when you make a deposit into the ILIT.
After 30 days have passed, the trustee can then use the money deposited in accordance with the trust guidelines; in the case of an ILIT to pay the insurance premiums. Because the beneficiaries have a right to withdraw the funds, the IRS treats the deposit as a present gift. As long as the deposit is less than $12,000 it will not be subject to gift tax.
Although an ILIT seems like a simple estate planning tool, you need to bear in mind that the payout from the insurance policy does not go directly to paying the estate taxes, but is first exchanged dollar-for-dollar with other assets in your estate. The funds from the insurance policy will then go into the estate, while the exchanged assets go into the ILIT. The benefit to this is that you do not have to liquidate your property in order to pay estate taxes. It is important to remember that some of your estate assets will be exchanged with the insurance payout and will end up in the ILIT when you are deciding who will be the trustee and the beneficiary of the ILIT.
Consult with an experienced Estate Planning lawyer at the Elder & Disability Law Center to create and maintain an ILIT.