Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Why a gift of life insurance?
 Life insurance proceeds can be removed from a client’s estate at a relatively low
cost
 A gift of other assets may results in a loss of a stepped up basis to the client’s heirs
 A gift of life insurance does not result in such a loss in income tax savings
 Psychologically, life insurance is an easier gift to part with
 Not income producing
 Thought of as a post death security vehicle for others
 Advantages of ownership of life insurance by a 3rd party
 Third party other than the insured’s estate owns, pays for, and is the beneficiary of
the life insurance policy
30 - 1
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Advantages of ownership of life insurance by a 3rd party (cont’d)
 Next best alternative
 Transfer existing policy by gift to insured’s spouse, or other trusted person
 Transfer policy to an irrevocable life insurance trust (ILIT)
 Lowers the overall tax burden
 Provides means of creating estate liquidity
 Liquidity for the estate without causing inclusion of the proceeds in the insured’s
estate
 If policy is owned or transferred to the insured’s children
 No estate tax is imposed until the next generation (to the extent the children have not
used the money)
30 - 2
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Disadvantages of ownership of life insurance by a 3rd party
 To avoid federal estate tax the client must give up direct control of the policy
 The transfer must be complete and permanent
 An absolute assignment or total change of ownership must be made if a presently existing
policy is to be removed from the client’s estate
 Unpredictable events can drastically change the way or the parties the client would
prefer to own coverage on his life





Unstable marriage
Insured may not get along with the children
Spouse could pre-decease the insured
Tax laws could change
Business reverses or opportunities may suggest a need for the insurance cash values
30 - 3
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Why make a gift to an irrevocable life insurance trust?
 Federal estate tax can be avoided at the client’s death and spouse’s death
 State death taxes can be saved in the same manner as federal estate taxes
 Little to no gift taxes are required to create and shelter life insurance from transfer
taxes
 No probate expenses, delays, or uncertainties with respect to the transfer of assets in
an irrevocable life insurance trust
 Trustee can use trust assets to provide estate liquidity, prevent a forced sale of a
family business, valuable real estate, or a securities portfolio, and keep treasured
property in the family
30 - 4
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Why make a gift to an irrevocable life insurance trust? (cont‘d)
 Significant income and capital can be provided for the surviving spouse
 Without causing inclusion in the surviving spouse’s estate
 The irrevocability of the trust generally translates into protection from the claims of
creditors
 Irrevocable trusts generally provide protection from a surviving spouse’s rights of
dower, courtesy, or right of election under state law
 A gift of a policy to a ILIT gives the insured more control over the ultimate
distribution of the policy and its proceeds, than would an outright policy gift
 Sprinkle and spray powers for the trustee are highly advantageous
30 - 5
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Why make a gift to an irrevocable life insurance trust? (cont’d)
 GSTT problems can be reduced or eliminated by judicious use of the GSTT annual
exclusion and GSTT exemption
 Using the ILIT as a vehicle to provide wealth replacement for the heirs
 Insure the estate tax savings for clients who establish GRITs, GRATs, GRUTs, or
charitable lead trusts in the event they die before the trust term ends
 Achievement of adequate financial security for those of modest means through the
leverage of life insurance
 General professional management, protection from creditors, postponement of
receipt of inheritance, and avoidance of guardianship of minors
30 - 6
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Disadvantages to ownership of life insurance by an irrevocable trust
 Client must give up
 Income produced by the trust
 Use and enjoyment of the property
 The right to name, add, subtract, or change the size or terms of a beneficiary’s interest
 The right to regain assets placed into the trust
 The ability to alter, amend, revoke, or terminate the trust
 Considerations
 Client can discontinue premiums or let the policy lapse and start over with a new trust
30 - 7
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Disadvantages to ownership of life insurance by an irrevocable trust (cont’d)
 Considerations (cont’d)
 Trust language could be drafted to give the trustee the authority to make distributions to
the beneficiaries prior to the client’s death
 Client could purchase the policies back from the trust for their fair market value
 Special power of appointment given to the insured’s spouse, an adult child, or someone
the insured implicitly trusts
 Power to appoint trust property to anyone other than the insured-grantor, his estate,
or creditors of his estate
 Name grantor’s spouse as original holder of the power but provide the power would pass
to a contingent holder:
 If spouse dies first
 If spouse is no longer married to the grantor
 If the spouse no longer has the legal or mental capacity to exercise the power
30 - 8
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Disadvantages to ownership of life insurance by an irrevocable trust (cont’d)
 Considerations (cont’d)
 Have a provision that would permit the trustee to collapse the trust and distribute it’s
assets to the beneficiaries
 Trustee could be given a power to sprinkle or spray income and principal among a class
of persons
 Trust could provide that if the grantor dies within three years of transferring the life
insurance policy to the trust, the proceeds would be paid to the insured-grantor’s executor
 Proceeds could then be channeled to the spouse and qualify for the marital
deduction
 Noninsured spouse could create a split dollar agreement with the trust in which the spouse
retains access to the policy cash values
30 - 9
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Disadvantages to ownership of life insurance by an irrevocable trust (cont’d)
 Up front and continuing cash costs
 May be termination fee if the trust is terminated before the life insurance policies
have matured
 Potential loss of the donor’s contributions out the back door of the trust
 Crummey powers
 Where the annual exclusions cannot shield the annual premium outlays, use of the
unified credit and then payment of gift tax
30 - 10
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Irrevocable Trusts – What it is and how it works
 Two ways an irrevocable trust becomes a life insurance trust
 Absolute assignment of policies to the trust
 Trust created and cash contributions made to the trust
 Trust purchases life insurance on the grantor
 ILIT may be funded or unfunded
 Funded – assets other then the life insurance have been placed in the trust
 Trust agreement should specify (a) what should happen if trust funds are insufficient
to pay the insurance premiums and (b) what should happen if there is an excess of
income
 Unfunded – trust contains only life insurance policies
30 - 11
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Irrevocable Trusts – What it is and how it works (cont’d)
 Tax objectives of trust
 Make maximum amount of income and capital available to surviving spouse
 Avoid inclusion of the proceeds in both spouses’ estates
 To accomplish these tax objectives, the draftsperson of the trust inserts certain
provisions that
 Allow trustee to sprinkle income or spray capital to spouse and children; and/or
 Give spouse “all of the income for life and as much principal as necessary for her health,
education, maintenance, and support”; and
 State “when she dies, my surviving spouse can appoint the remainder of the trust assets
among our then living children”
30 - 12
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Irrevocable Trusts – What it is and how it works (cont’d)
 Caution – if the provisions of the trust required the trustee to pay to the insured’s
estate any cash needed to pay debts, expenses, and taxes
 This provision would result in federal estate tax inclusion of all amounts that could be so
expended
 Solution – trust provision authorizing, but not directing, trustee to
 Lend money to estate at an appropriate interest rate
 Purchase assets from the estate at their fair market value
 Estate should realize little to no gain on the sale because appreciated assets receive a
stepped up basis at death
 Trustee takes that asset with a basis that is stepped up to its purchase value
30 - 13
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Mechanics
 Attorney drafts and client signs the irrevocable trust document
 Trustee then applies for the policy on the insured’s life
 Alternatives
 Plan A
 Client applies for the policy as policyowner
 Client transfers ownership of the policy to the trust by an absolute assignment
 In a “nonprepaid” case, an informal application is submitted, and once the policy’s
issues status is known, the trust is established, and then the trust formally applies for
the policy
 Plan B
 Client applies for term insurance
 Once the trust is established, trustee applies for a new form of permanent policy and
the term policy can be lapsed
30 - 14
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Mechanics (cont’d)
 Alternatives (cont’d)
 Plan C (the “substitute application”)
 Applicant, owner, and policy date of a recently issued policy (less than a year old)
are changed to coincide with the effective date of the trust
 Client can transfer existing policies to the trust via an absolute assignment
 Client must survive three years after the transfer in order for the proceeds to be
excludable from his gross estate
 Selection of a trustee
 Grantor-insured as trustee
 IRS could argue insured has retained an incident of ownership that causes the insurance
proceeds to be includable in his estate
30 - 15
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Selection of a trustee (cont’d)
 Spouse of the grantor-insured as trustee
 If spouse is given a general power of appointment over the policy in the trust, the
proceeds will be in the spouse’s estate
 Safeguards
 Name at least one other individual or corporate fiduciary as co-trustee
 Specifically exclude the surviving spouse from all potential exercises of incidents of
ownership in the policy held by the trust insuring the spouse’s life
 Allow distributions to the surviving spouse only if and when the principal of the
marital trust is exhausted
 Forbid any distributions to individuals that would relieve or discharge the spouse
from a legal support obligation
30 - 16
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Selection of a trustee (cont’d)
 Spouse of the grantor-insured as trustee (cont’d)
 Safeguards (cont’d)
 Limit the surviving spouse to a special power of appointment over trust assets, but
specifically exclude from this power the right to dispose of life insurance on the
spouse’s own life
 Exclude the surviving spouse as trustee from making any decisions involving the
distribution of principal or income to the spouse as a beneficiary except those
limited by a health, education, maintenance, and support ascertainable standard
 Consider the existence of the trust during two time periods
 Who should be trustee during the insured’s lifetime?
 Who should be the trustee thereafter?
30 - 17
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers
 Transferring a policy to a trust is a gift subject to the gift tax
 The tax depends on the value of the policy, the availability of the annual exclusion, and
the unified credit
 If the annual exclusion is available, then up to $12,000 (in 2008) is shielded, and up to
$24,000 (in 2008) if the client is married and the spouse consents to the gift
 Gift tax valuation rules
Policy Transferred
New policy transferred immediately after issue
Gift Tax Value
Cost (net premiums paid)
Existing policy - no further premiums due
In the case of a single premium or paid-up policy, cost of
replacement
Policy in "premium paying" stage
"Interpolated terminal reserve" plus any unearned premiums
paid on the date of death less any policy loans
Group term life insurance
At the client's option - the actual cost or Table I cost
Policy is about to mature on the date of transfer
IRS may value the policy at or near its face amount
30 - 18
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 Minimize the gift tax exposure
 Borrow cash value out of policy before making gift
 One large policy could be split into several smaller ones and staggered gifts could be
made to the trust
 The annual exclusion is available only for gifts of “present interest”
 Donee must receive the immediate, unfettered, and ascertainable right to use, possess, or
enjoy the transferred property
 Outright transfers of a life insurance policy qualify for the annual exclusion
30 - 19
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 Gift of life insurance to a trust
 A gift of an insurance policy to a trust will be a gift of a future interest
 Absent the annual exclusion, each time a client made a contribution to the trust to enable
the trustee to pay premiums, the client would have to use up more of his unified credit to
avoid gift taxes
 The solution
 Create a “window" through which the beneficiary could reach to take all or a portion of
that annual contribution
 This window is called a “Crummey power”
 Trust must specify that each trust beneficiary to whom a Crummey power is to be
granted is given an absolute but noncumulative right to withdraw a specified
amount from the client’s annual contribution
30 - 20
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 The solution (cont’d)
 Crummey power
 Limit to the lowest of
 Amount of the annual exclusion per donor/donee per year
 The amount actually contributed
 The greater of $5,000 or 5% of the value of the trusts assets at the time of the
withdrawal
 Window must be allowed to remain open long enough to give the beneficiary a
meaningful interest in the property given to the trust
 trustee should keep sufficient funds in the trust during the open window so that a
demand can be realistically and immediately satisfied
30 - 21
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 The solution (cont’d)
 Crummey power (cont'd)
 Notification should be made by the trustee to all demand powerholders of the right
to make withdrawals
 In the case of minors, notice should be given to the parent or legal guardian
 There is no specific number of days during which a demand power can be exercised
that assures that a demand power will create a present interest
 30 days from the date of notice seems to be the shortest reasonable period
 If the window were opened too high (i.e., the “5 or 5 power” limit was not included)
 The value of any unexercised demand existing at the beneficiary’s death would
be included in his estate
30 - 22
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 The solution (cont’d)
 The “5 and 5 Power”
 Allowing a general power to lapse or expire is treated for gift and estate tax
purposes as a release (as if the powerholder made an actual transfer of the property)
 The de minimis rule
 The gift/estate tax problems of the powerholder who doesn’t exercise the
power is avoided to the extent the lapse of the power does not exceed the
greater of $5,000 or 5% of the value of the trust assets at the time of the lapse
 When a trust is unfunded
 Only two sources from which the demand right can be satisfied
 The cash contribution made by the grantor to the trustee in order to pay premiums
 The life insurance policy itself
30 - 23
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 When a trust is unfunded (cont’d)
 Conservative planners may protect the insured-grantors gift tax exclusion even further by
funding the trust with other assets other than the life insurance policy
 Recommended course of action is for the insured-grantor to make cash contributions to
the trustee that the trustee could hold for the duration of the demand period
 At expiration, the trustee could pay premiums with this contribution
 Giving the spouse a Crummey power
 Client may be worried that children or other donees will exercise their demand
power and thus defeat the purpose of the trust by depriving the trustee of the funds
from which to pay premiums
 The client may want to increase the number of annual exclusions
30 - 24
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on policy transfers and premium payments
through Crummey powers (cont’d)
 When a trust is unfunded (cont’d)
 Giving the spouse a Crummey power (cont’d)
 Limit power to annual amount not exceeding $5,000 or 5% of the trust fund
 Higher powers would invite IRS inclusion of the policy proceeds in the spouse’s
estate
 If the grantor’s spouse has a requisite beneficial interest in the trust, the IRS could
argue that the lapse of the spouse’s demand power is equivalent to the release of a
general power of appointment
 IRC 2041(a)(2) – decedent’s gross estate includes the value of property subject
to a general power of appointment that was released or exercised before the
decedent’s death , if the result of the release or exercise is the creation of a
retained interest described in IRC Sections 2035, 2036, 2037, or 2038
30 - 25
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers
 Where premium outlays will exceed the greater of $5,000 a year or 5% of trust
assets in the year of the grantor’s contribution
 Client opens the window too much
 By allowing the general power to lapse, the beneficiary who could have taken the cash
but didn’t, is making a taxable gift to anyone who has interests in the trust that are
enlarged by the lapse
 The gifts are gifts of a future interest and are ineligible for the gift tax annual exclusion
 The Crummey beneficiary who permitted the withdrawal to lapse would be required to
file a gift tax return and may have to use part of his unified credit or pay a gift tax
30 - 26
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 Policies with large premiums – minimizing the problem
 Use a limited pay type policy
 Example – A ten pay policy would be complete in ten years. Amount saved in estate
taxes would be considerable compared to the relatively small gift taxes paid during
the ten year period
 Use vanishing premium type arrangement
 Increase the number of legitimate powerholders
 Add testamentary control
 Can exercise power of appointment by will only
 Prevents taxable gift when Crummey power lapses
 Two ways – general or special power of appointment
30 - 27
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 General testamentary power technique
 Each beneficiary given a general testamentary power of appointment over his
share of the trust
 Each beneficiary can choose who will receive that share of the trust if the
beneficiary doesn’t live to get it
 That right can be exercised only at death and only by a specific provision in the
beneficiary’s will referring to the general power in the trust
 The trust provides that if the beneficiary doesn’t properly exercise the power,
then the property will pass to the other beneficiaries in the trust
 Downsides
 Property subject to this power will be in powerholder’s estate
 Equates to a loss of control by the client-grantor
30 - 28
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 Special testamentary power of appointment technique
 Grant each beneficiary only a limited power of appointment
 If the beneficiary dies, his share will pass to whomever he provides by will within a
client-specified class, such as the powerholder’s siblings
 The powerholder’s choices are limited by the client-grantor
 Downsides
 Property subject to the power will be in the powerholder’s estate if the powerholder
does before the trust ends
 Powerholder’s controlled ability to shift property rights equates to a loss of control
by the client-grantor
30 - 29
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 Use a hanging power
 The powerholder is allowed to make a withdrawal each year equal to his share of the
client’s contribution, up to the maximum annual exclusion
 The right to that aliquot share is cumulative
 To the extent no withdrawal is made in a given year, the balance hangs over and can
be used in a following year
 Example - Client contributes $10,000 to trust with one powerholder
 Right to first $5,000 lapses, the right to withdraw the remaining $5,000 would
continue
 By the second year $10,000 worth of contributions would have lapsed, but
$10,000 worth of excess contributions are now available as credits against
future years
30 - 30
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 Use a hanging power (cont’d)
30 - 31
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate and income tax problems related to Crummey powers (cont’d)
 Use a hanging power (cont’d)
 If the beneficiary dies while amounts remain available at the beneficiary’s demand,
whatever is subject to that demand is included in the powerholder’s estate
 Beneficiaries could frustrate the client’s intent by making withdrawals of large amounts
 Client’s should carefully select powerholders who are mature enough to understand
the client’s objectives and the potential consequences of their actions
 IRS has disallowed a hanging power written as a tax savings clause as adverse to public
policy
 The single beneficiary trust
 Providing separate trusts or separate trust shares
 If client is willing to give up flexibility
30 - 32
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 The single beneficiary trust (cont’d)
 Disadvantages
 Trustee cannot make discretionary trust distributions to persons other than the
beneficiary, since there is only one beneficiary
 All income and principal must be payable to the estate of the beneficiary if the
beneficiary dies before the trust pays out all its principal
 Each beneficiary must be given a testamentary general power of appointment over
his trust share
 Trust assets cannot be sprinkled or sprayed to the person who needs it or deserves it
most
 Property will pass as if owned by the beneficiary, possibly to a person objectionable
to the client
30 - 33
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Gift, estate, and income tax problems related to Crummey powers (cont’d)
 The single beneficiary trust (cont’d)
 Disadvantages (cont’d)
 Property will be includable in the beneficiary’s estate
 The property may be distributed (due to the untimely death of the beneficiary) prior
to the date expected by the client
 Grant withdrawal rights to secondary/contingent beneficiaries
 The “Cristofani Case”
 Contingent beneficiaries given withdrawal rights and were entitled to principal only
to the extent the prior beneficiaries had not exhausted the trust
 IRS argued that this level of powerholders had such a remote chance of actually
receiving assets from the trust that there must have been some implied
understanding between them and the client-grantor that they would not make such a
withdrawal
 The tax court disagreed – powerholders had absolute legal right of withdrawal
30 - 34
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on premium payments through methods other
than Crummey powers
 Split Gifts
 Having the nondonor spouse agree to be treated if he had made one-half of the gifts made
by the donor spouse
 Election for split gifts is made on the gift tax return for the year in which the gift is made
 Permanent withdrawal rights
 The powerholders’ rights do not lapse and therefore grow each year
 Larger premiums can be paid and sheltered by the annual gift tax exclusion
 Downside
 As the value of the property that can be taken grows, so does the beneficiary’s
temptation to make a withdrawal.
30 - 35
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Reducing or eliminating gift taxes on premium payments through methods other
than Crummey powers (cont’d)
 All out maximum transfers
 Example
 Client transfers $200,000 (doubled to $400,000 with gift splitting) in 2008
 Excess over $24,000 will not qualify for the annual exclusion, so client must use his
unified credit to avoid a current gift tax liability
 Once at least $200,000 of assets are in the trust, the greater of $5,000 or 5% is
$10,000
 So, from this point forward, the client can make gift tax free gifts of the maximum
exclusion amount
 Even if the beneficiary doesn’t exercise his withdrawal rights, no taxable gift occurs
because the entire contribution is shielded by the de minimis greater of $5,000 or
5% trust principal rule
 Downside
 Client must be willing to use all or a large portion of his unified credit
30 - 36
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 What the attorney should consider in drafting
 The right of the Crummey power beneficiaries to make withdrawals extends to
contributions to the trust from all sources
 The amount subject to the Crummey power should be limited to the smallest amount
that will protect the client’s annual contributions
 Require the trustee to give return receipt requested notice of any additions to
principal and keep the right of withdrawal open for at least 30 days
 Require the beneficiary exercise the withdrawal right well within the policy’s grace
period for payment
 Require that the beneficiary exercise withdrawal rights in writing
30 - 37
Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 What the attorney should consider in drafting (cont’d)
 Allow any power given to a minor beneficiary to be exercised on his behalf by a
guardian
 Terminate the power of withdrawal upon the insured’s death
 Name backup powerholders so that, if a primary Crummey powerholder dies, the
annual exclusion is not lost
 Have the grantor irrevocably renounce all rights in any policies or other assets in the
trust
 Be sure the noninsured spouse pays no premiums and contributes no premiums,
policies, or other assets to the trust
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 What the attorney should consider in drafting (cont’d)
 The trustee should be given a duty to collect proceeds and indemnification for costs
involved in a suit if required
 Give the trustee the right to take one or more policy death benefits under the
settlement options provided by the insurer
 In community property states, the grantor should indicate that any insurance
contributed to the trust was the separate property of the grantor
 Do not require that the trustee purchase life insurance or apply contributions to the
trust to be used to buy life insurance or pay life insurance premiums
 Trustee must act independently in the purchase of the insurance and not as the
client’s agent or at the client’s direction
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 What the attorney should consider in drafting (cont’d)
 Do not allow the client to sign the policy application as applicant or owner
 Do not allow the trustee to merely endorse the client’s contribution to the trust each
year and send them on to the insurance company
 How to avoid the transfer within three years of death rule
 Be sure the client never owns the policy
 Suggest to the independent trustee the advantages of owning a policy on the life of
the “to be insured,” but let that party make the decision and take all the action to put
the policy into effect
 Authorize, but do not require, the purchase of life insurance
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 How to avoid the transfer within three years of death rule (cont’d)
 Expand the authority of the trustee to purchase life insurance on the life of anyone
on whom the trust beneficiaries have an insurable interest
 Specifically deny the insured the power to acquire any rights in a policy currently
owned by the trust
 Permit, but do not require, that the trustee pay premiums
 A client’s gift of existing life insurance must be made with no strings attached
 Be sure that facts indicate that the trustee is not acting mechanically as the agent of
the client
 If possible, during the first three years, have the trustee pay premiums from a source
other than the insured.
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 How to avoid the transfer within three years of death rule (cont’d)
 Be sure that the trustee physically obtains and retains possession of all polices
assigned to the trust
 Authorize the trust to enter into a special arrangement with the client’s corporation
or other business enterprise or a third party for splitting premium dollars and policy
ownership
 Avoiding transfer for value rules with a trust
 The transfer was to the insured, if the trust was defective
 If the irrevocable trust was a partner of the insured, the transfer falls within one of the
exceptions
 Section 1035 exchanges should not cause a new three year period to commence for
estate tax purposes under Section 2035
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Structuring the trust for “what ifs”
 Escape or failsafe contingency provision
 Requires the trustee to hold any insurance proceeds that are included in the grantor’s
estate, and to pay them out in a manner that qualifies the proceeds for the estate tax
marital deduction
 As a general power of appointment or as a QTIP deduction
 Clause could obtain the marital deduction by providing for
 Outright payment of the insurance proceeds to the surviving spouse
 Income interest to the surviving spouse coupled with a general power of
appointment
 Payment of the proceeds to a trust the surviving spouse can revoke at will
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Allocation of the federal estate tax
 The IRC allows the insured to specify, by an allocation clause in his will, who will
bear the burden of any estate tax
 Income tax implications
 Grantor trusts
 Income taxed to the grantor and any deductions, gains, losses, or credits realized by the
trust can be used by the grantor
 What will cause the trust to be considered a grantor trust?
 Retention by the client or the client’s spouse of a reversionary interest in the income or
principal in the trust
 Only if the actuarial value of the retained reversionary income is greater than 5% of
the value of the income or principal that may revert
 Retention of the power to control the beneficial enjoyment of the income or
principal of the trust
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Income tax implications (cont’d)
 What will cause the trust to be considered a grantor trust? (cont’d)
 Retention of certain administrative powers
 Power to purchase, deal with, or dispose of the income or principal of the trust for
less than adequate and full consideration
 Power to borrow income or principal without adequate interest or security
 Related or subordinate trustee lends income or principal without adequate collateral
or reasonable rate of interest
 If someone other than the trustee can vote corporate stock held by the trust, or has
the power to control the investment of stock or securities held by the trust, or has the
power to reacquire the principal of the trust by substituting property of equal value
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Income tax implications (cont’d)
 What will cause the trust to be considered a grantor trust? (cont’d)
 Retention of the power to revoke the trust by the client or a nonadverse party
 If trust income is, or in the discretion of the client or a nonadverse party, may be
 Distributed to the client or his spouse
 Held or accumulated for future distribution to the client or his spouse
 Used to pay premiums on a policy on the life of the client or his spouse
 Used to discharge a legal obligation of the client or his spouse
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 How to handle last-to-die insurance in an irrevocable trust
 Reasons to use these policies
 Payment of proceeds often tracks with the estate’s need for cash
 Lower outlay than if the same amount of coverage were obtained by the older insured
 Guidelines
 Do not name either spouse as a life beneficiary of the trust
 Do not name either spouse as trustee
 IRC 2035
 Only if (a) both spouses die with the three year period following the transfer, and
(b) the transferor spouse is the second to die
 The life insurance proceeds will be includable under the three year rule
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 How to handle last-to-die insurance in an irrevocable trust (cont’d)
 Guidelines (cont’d)
 Situations where last-to-die policies are not indicated
 Where client wants to pass significant wealth to someone other than the surviving
spouse
 Where there is no surviving spouse
 Where the surviving spouse is not a U.S. citizen and a QDOT is contra indicated
 Where the funds needed to maintain the surviving spouse’s standard of living will
require significant capital
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 How to handle group term life in an irrevocable trust
 Group term life is an ideal transfer where
 It makes a significant estate tax savings possible at a minimal gift tax cost
 Considerable psychological advantage
 Employee feels cost is low since “little of current value” is given up
 Special problems
 Assignability
 Obtaining the annual exclusion
 Community property issues
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Community property issues
 Community property states
 Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and
Washington. Wisconsin is a quasi-community property state
 Life insurance
 Acquired by one or both spouses during the marriage while domiciled in a
community property state is typically considered community property
 Each spouse is the owner of one-half of the policy
 Adverse consequences
 Noninsured spouse’s interest in the community property may be includable in her
estate
 A noninsured nongrantor has made a gift of her interest if community property was
used to pay premiums on the policy
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Irrevocable Life Insurance Trusts
Chapter 30
Tools & Techniques of Life
Insurance Planning
 Community property issues (cont’d)
 Life insurance (cont’d)
 To avoid inclusion in estate, do not
 Give either spouse a life income in the trust
 Convert the insurance, prior to the transfer to the trust, to separate property
of the insured
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