IRREVOCABLE LIFE INSURANCE TRUSTS
By Roger C. Hurd
HURD, HORVATH & ROSS, P.A.
Palm Beach Gardens, FL
An Irrevocable Life Insurance Trust is a Trust established by the grantor to hold or own insurance policies on the life of the grantor/grantors. By retaining no control over the Trust those proceeds are not considered part of the grantors estate for federal estate tax purposes.
For example, a $1,000,000.00 insurance policy owned by the decedent at the time of death will incur federal estate tax of between $370,000.00 and $550,000.00. The same policy owned by the Trustee will incur no federal estate taxes. (Note: there is a three year recapture of policies transferred by the decedent to the Trustee. New policies purchased by the Trustee are not subject to recapture).
Even the transfer of a $100,000.00 policy will save at least $37,000.00 in federal estate taxes.
The greatest advantage of the irrevocable life insurance trust is, of course, the potential tax-free appreciation between (a) the relatively small amount of dollars paid as insurance premiums plus any gift tax cost, and (b) the tax-free proceeds received from the insurance policy upon the estate owner's death.
Another important advantage is that the trust receives the tax-free proceeds the very moment the estate owner's estate taxes accrue. The trustee can use the proceeds to lend money to the insured's estate or to purchase assets from the estate, and thus provide the funds needed to pay Federal estate tax and state death taxes. The significant point, of course, is that the funds used to pay the death taxes are not themselves included in the insured's taxable estate.
Often, the use of these funds makes it possible to keep the family business in the family. The trustee can purchase stock in the corporation or make a short term or long term loan to it. With the assurance that these tax-free funds will be available when needed, there is a comfortable feeling among the parents and the children that the business will continue down the line.
The gifts of the money to the trust to pay the premiums on the insurance policy will be subject to gift tax, because they are gifts of "future interests." There is, however, a reliable way to use $10,000 of the annual gift tax exclusion for each beneficiary. It is called the Crummey power, named after an important court opinion. Under this arrangement, the donor makes a gift to the beneficiary of the trust estate and provides in the trust that he or she has 30 days to withdraw the gift. If he or she does not draw the gift down within that time, then the option lapses and the property remains in the trust free of gift tax.
If the estate owner wishes to have his estate continue for two or more generations and if his and his wife's estates exceed $3,000,000, the trust makes it possible to avoid the confiscatory 55% generation skipping tax (GST). There is a highly technical point, however, that must be scrupulously observed. When the estate owner contributes the amount of the insurance premium to the trust, he must not use the GST annual exclusion. Rather, he must each year use a small part of his $1,000,000 lifetime GST exemption. The reason is that, to use the annual exclusion, the donor must give it to the trust beneficiary in such form that it will be taxable in the beneficiary's estate.
The trust instrument must have certain provisions regarding the investment of trust funds in insurance policies on the estate owner's life or on the life of any person in whom a beneficiary has an insurable interest. These powers should be included in the trust instrument with the other investment powers.
If it is contemplated that the trustee will purchase stock of the family corporation or make loans to it, there should be both a detailed section regarding the trustee's powers and the exoneration of the trustee from any losses resulting from its exercise of these powers.
Another paragraph should cover the trustee's power to purchase assets from the insured's estate or the spouse's estate at fair market price.
There are a variety of ways the insurance premiums can be paid. All of the following have been used in the decided cases:
1. Direct gifts of money to pay the premiums.
2. A pre-authorized right to the trustee to withdraw funds from one of the insured's bank accounts.
3. A pre-authorized right to the trustee to withdraw funds from one of the family corporation's bank accounts. Presumably, the amounts withdrawn would be treated as loans to the insured stockholder-officer. The loans should be evidenced by promissory notes bearing the customary interest rate.