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Life insurance proceeds when paid at the death of the insured are usually not subject to income taxes at death but are includible in one’s estate for estate tax purposes. With a properly drafted and administered Irrevocable Life Insurance Trust (ILIT), the death benefit of a life insurance policy could be excluded from estate taxes. This is why Irrevocable Life Insurance Trusts (ILITs) serve as a powerful estate planning tool. As with most trusts, an ILIT allows the assets to be distributed to beneficiaries based upon the terms set forth in the trust document and it could also provide increased creditor protection.

Your advisors at Wealthstream Advisors will help clarify how much life insurance is needed for survivorship needs and legacy goals. They will also help you determine if establishing an ILIT makes sense for your situation. If establishing an ILIT is appropriate, it is important to work with a qualified estate attorney to make sure that the trust document has the correct language to avoid estate tax inclusion.

The grantor that establishes the ILIT must relinquish control over the trust and name one or more trustees to manage and administer the trust assets. Proper administration of the ILIT is key to ensuring that the assets are excluded from potential federal estate taxes.

This guide was written based on current tax law. As there may be changes soon that could affect ILITs, we will update this resource accordingly.

Establishing & Funding An ILIT

Make ILIT the owner and the beneficiary of the life insurance policy.

If the grantor transfers an existing life insurance policy they own to the ILIT, the grantor must survive for 3 years after the insurance is gifted into the trust to avoid estate tax exclusion. Speak to your Wealthstream advisor as there may be way to sell the policy to the ILIT and avoid this rule.

Best Practice:
Have the ILIT apply for the life insurance policy from the outset in order to avoid the 3-year look back rule.
Work with the estate attorney and accountant to confirm and establish the following:    

Is the ILIT intended to be Generation Skipping Tax (GST) exempt? i.e. should you allocate GST exemption or optout?

 Yes No

Is the ILIT a grantor trust or a non-grantor trust?

 Yes No

Does a Tax ID (EIN number) need to be obtained for the trust?

 Yes No

Does the ILIT document contain “Crummey Powers” that allows for annual exclusion gifts?

 Yes No

If yes,

  • Note how much of the annual exclusion limit is being allocated to the trust beneficiary for the premium payment. Take into account other annual exclusion gifts made to the same beneficiary.
  • Obtain from the estate attorney a draft of the “Crummey Letter” that needs to be signed and instructions.
  • Determine if need to establish non-interest bearing checking account in the name of the ILIT.
    

Annual Review/Ongoing Administration For An Already Established ILIT

Steps:

1. 

Grantor gifts enough cash into the trust account 60-90 days prior to premium payment due date. 
2. 

When the gift is made to the trust by the Grantor and assuming the trust includes Crummey Powers, Trustee sends the Crummey Letter to the trust beneficiary(ies). 
3. 

Beneficiary(ies) sign the Crummey letter (should be the nongrantor spouse or the guardian if the beneficiary is a minor). 
4. 

After Crummey letters are signed and the right of withdrawal time has lapsed, Trustee to then pay the premium. 
5. 

Provide CPA with annual gift information to see if a gift tax return should be filed for contributions to the ILIT. 
6. 

Trustee to work with CPA to file federal and state fiduciary income tax returns for the trust and issue K-1 form 1041 to beneficiaries if applicable.

Life Insurance Policy Review

Trustee has fiduciary duties which typically includes conducting periodic evaluation of the trusts’ insurance policies:

For permanent policies (i.e. Whole Life, Universal Life, Variable Life)

    

When was the last time an in-force illustration was requested to see how the policy is performing?

 0-2 Yrs 2+ Yrs

Should the policy be replaced/structured differently?

 Yes No

Is there cash value built up that could be used to service the premiums without damaging the long-term viability of the policy?

 Yes No

Is the insurance carrier strong?

 Yes No

For variable policies specifically,

    

Has the Trustee reviewed and selected investments and determined suitability?

 Yes No

For term policies

    

Is the term reaching an end and is there a desire to extend?

 Yes No

Is there a desire to change this to a permanent policy for legacy needs?

 Yes No

Is there a conversion feature to turn this into a permanent policy without a need for underwriting?

 Yes No

If the trust is funded with other assets other than life insurance policies:

    

Have the assets been managed or reviewed?

 Yes No

Other

  • Keep original copies of document in a safe/a vault as well as an electronic copy along with most recent statements.
  • Save copies of premium checks paid.
  • Keep all correspondences between the trustee, beneficiary, attorney and Wealthstream advisor.

 

It is important that those that have established ILITs work closely with their financial advisor, estate attorney, accountant, and trustee. Please reach out to a Wealthstream advisor if you have any questions on how we can help with your specific situation.