Life insurance is a great method to fund an estate and a great way to provide for the welfare of your surviving family members. However, in order to maximize the benefits of an insurance policy it is vitally important that its ownership and administration be structured properly. One of the best ways to do this is by placing the insurance policy in an Irrevocable Life Insurance Trust (“ILIT”). Because a properly created ILIT is viewed in the eyes of the law as a separate legal entity, creating one ensures that the proceeds will be separate from your estate and therefore not subject to estate taxes.
In order to qualify for this individualized tax treatment, certain rules must be followed. For example, as the insured, you must give up control and ownership of the trust. Therefore, you cannot be the trustee. It is also important to note that if the ILIT is paying out to your children and you wish your children to be trustees as well, there should be an independent co-trustee appointed to oversee payments from the trust.
Consideration must be given to how the insurance premiums are to be paid after the ILIT is created. The ILIT can be set up either with a lump sum gift, and then the premiums deducted from this amount as needed, or the settlor can make periodic payments into the ILIT to cover the premium amount. However, both payment methods have different tax implications. So it is important that these are discussed with your legal professional.
A settlor of an ILIT can either purchase a new insurance policy or can have an existing policy transferred into the trust. However, it is better to create the trust with a new policy because if you transfer an existing policy into the trust and you do not survive at least three years after the date of the transfer, the policy may be considered part of your estate and taxes could be taken out from the insurance proceeds. This is an important item to think about when you begin setting up your ILIT.
Because the goal is to structure the ILIT so that it is kept out of your estate, you must give up control of the ILIT. This means you will not have the right to amend or revoke the policy or trust once created. What this means is that it is important to set up the ILIT correctly. To set up an ILIT properly, it is important to hire an experienced attorney capable of preparing the ILIT with your goals in mind.
If you have further questions about ILITs, contact Daniel Geraldi at (925) 364-4741.