Do You “Trust” Your Irrevocable Life Insurance Trust?
In years past, when the estate tax exemption (technical name is applicable exclusion amount) ranged from $600,000 to $3,500,000, many individuals created irrevocable life insurance trusts to hold life insurance that would “balloon” on a person’s death and the life insurance proceeds would provide liquidity for payment of the decedent’s estate taxes. An example will illustrate.
Harry had an estate of $2,000,000 when the exemption was $1,000,000. If no other deductions are allowable he would have had an estate tax of 50% of $1,000,000 ($2,000,000 less the $1,000,000 of exemption) or $500,000. Harry does not want his wife or children to have to come up with the cash to pay the estate tax that is due 9 months after his death, so he thinks about buying life insurance. Unfortunately, if he buys life insurance in his name, then the life insurance proceeds will just increase the size of his estate and the estate tax will increase.
Alternatively, if Harry creates an irrevocable life insurance trust (“ILIT”) and a trustee (who can not be Harry) of the ILIT purchases life insurance on Harry’s life, and if Harry has no incidents of ownership in the trust, as provided under Section 2042 of the Internal Revenue Code, then the life insurance proceeds should NOT be included in Harry’s estate when he dies. Such proceeds, however, would be available to Harry’s spouse and children to pay the estate tax. This liquidity could be very helpful, especially if the largest asset in Harry’s estate is real estate or a non liquid business.
Now that the exemption is $5,340,000 many people believe that their existing ILITs are not necessary for the purposes they were created. NOT SO FAST!… Many clients may stop paying premiums and lose the benefits of the cash value of those policies. While the original purpose MAY not be the current reason for keeping the ILIT, depending on how long premiums have been paid and whether you are still insurable, you do not want to do anything until you discuss with your attorney and a QUALIFIED insurance consultant.
Access to the life insurance policy in the ILIT could help with your retirement (you may not care if you have an incident of ownership since the exemption will cover your estate tax), death benefits could help your children with school, the trustee may be able to exchange policies to reduce the size of the premium payments or the trustee may be able to sell your policy to another trust with more favorable provisions.
ADVICE: If you have an ILIT, or are thinking about one, then any decisions on maintaining or purchasing the life insurance policy MUST be discussed with your attorney and a QUALIFIED insurance agent. Don’t throw the ILIT out of your tool box. There may be very good reasons to keep the ILIT and your consultants can help you sort through those reasons and make sure that you are not losing or wasting money.
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