In Trusts and Estates | On November 1, 2015
As discussed in a previous post, irrevocable life insurance trusts (ILITs) are a relatively common subset of irrevocable trusts. Because the goal is typically to get the life insurance out of the policy owner’s taxable estate, both the owner and the beneficiary must be, or change to, the trust; and there are also other steps that must be taken to administer the ILIT properly.
As with any irrevocable trust, the first question is whether the ILIT will or won’t be a grantor trust—see the earlier post on funding irrevocable trusts for a discussion of that point. Whether an ILIT will be a grantor trust depends on its governing provisions, which in turn depends on what the grantor wants.
When the ILIT is created at the same time the insurance policy is bought, ideally the ILIT should be designated to own the policy from the very beginning of the application process, but definitely by the time the policy is issued. If the ILIT becomes the owner at any time after the policy is issued, and the insured dies within three years of that transfer date, the policy will still be considered to be owned by the insured—and thus a part of the insured’s estate for estate tax purposes, which would defeat the purpose of most ILITs. Having the ILIT own the policy from its inception will avoid this three-year look-back rule. Regardless of when the ILIT will become the owner of the policy, the insurance company can assist you in the ownership change process.
Remember that the ILIT should also be named as the beneficiary of the policy; if this wasn’t done when the policy was issued, request a change of beneficiary designation form from the insurance company immediately.
The ILIT trustee will also need to set up a bank account for the ILIT (using either the grantor’s social security number or the trust’s Taxpayer Identification Number (TIN)—again, see the related post on funding irrevocable trusts for more information). This bank account will hold the funds that the grantor contributes to the trust while the period for trust beneficiary to withdraw funds elapses; if the trust beneficiaries don’t do so, the trustee then pays the policy premiums from this account.
Finally, the trustee must send letters to the beneficiaries of the ILIT, notifying them of their right to withdraw some or all of the amount the grantor gave to the trust by a stated deadline, as also discussed in the post on ILITs generally.
Following the required steps in administering ILITs can make the difference in any later estate tax audit by the IRS, so good implementation and record-keeping is essential.
Consult your estate planning advisors with any questions. Visit The Connolly Gallagher Trust & Estate page by clicking here.