Creating Value for Clients with
ILITs - a Team Approach
An ILIT For All Seasons
January 25, 2011
Bill Conway & Lou Shuntich
www.advisorsforum.com
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Fundamental Principle
• Estate planning is not just about saving
taxes.
• Rather, it is about taking care of
yourself and your family and then with
proper planning doing it at the lowest
tax cost possible.
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Putting Things In Perspective
• The increase in the Estate Tax Applicable Exclusion
Amount to $5 million has significantly decreased the
number of clients who need to be concerned about
estate taxes
• Yet, based on 2001 information American families
with a net worth of more than $10 million numbered
338,400*
• In addition, There are over 6 million U.S. households
with a net worth of $1 million to $5 million**
LSI Estate Planning Newsletter #1729 (December 13, 2010) AT
http://www.leimbergservices.com
•
**January 2009 Journal of financial Service Professionals
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The Problem = Constant Change
• The increase in the Estate Tax Applicable
Exclusion only applies to 2011 and 2012 with
no certainty as to what the future holds
• This presents a need for flexibility in planning
so that clients can be responsive to changes
in the transfer tax laws while attending to their
personal and financial needs
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Estate Tax Reducing Techniques
• Two common threads:
– You must change how you own or manage your
property
– You must make substantial gifts to the next
generation
• Problem:
– As people grow older they do not like change
– Making large gifts can make them feel financially
vulnerable
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The ILIT Alternative
• Purchase life insurance to cover needs
and taxes through an Irrevocable Life
Insurance Trust (ILIT):
• Customers do not have to change their
lives and may go on living as they always
have
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Avoiding Estate Tax Inclusion
• The prospective insured must be willing to
give up control of the life insurance to keep
the death proceeds out of their gross estate
under IRC § 2042
• The coverage must be purchased and owned
by a third party
– Family member: no certainty that the proceeds will
be used as intended
– ILIT: The terms of the trust control the use of the
death proceeds
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$5 Million Gift tax Exclusion
• The 2010 tax act creates a 2 year window of
opportunity to make a $5 million gift tax and
GST tax free transfer to an ILIT
– The gift may be in cash to pay premiums, or
– It may be a gift of income producing property that
will generate income to pay premiums or for other
purposes
– If the ILIT is structured as a grantor trust the ILITs
earnings will compound income tax free
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Drafting to Provide Liquidity
• Trustee is authorized to lend to the
estate
• Trustee is authorized to purchase
assets from estate
• Wealth Docs includes these provisions
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Drafting ILITs
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Individual or Joint Grantors
Family (mirror RLT Bypass Trust)
Divorce or Annulment Provision
Life Insurance Provisions
– Authorization to invest in life insurance polices
– Investment in off shore insurance
– Use of income to purchase insurance
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Drafting for Indirect Access
• Loans to grantor
– Trustee borrows against policy and reloans
– If adequately documented and secured,
should be no incident of ownership
– No taxable income – trust is grantor trust
under IRC 675(3)
– Note plus accrued interest is debt against
estate
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Drafting for Indirect Access
• Inter-vivos Bypass Trust (Family Bank
Trust/BERT)
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–
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Spouse has access
Income taxable to grantor (payable on joint 1040)
Not included in spouse’s estate
At spouse’s death (LPA?)
Danger is reciprocal trust doctrine
• Self-Settled Trust Jurisdictions
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“Family Bank Trust”
• Create as a grantor trust;
• Sell appreciated assets tax-free;
• Remove assets + future appreciation from gross
estate;
• Grantor pays any income tax liability created by
income from trust assets;
• Trust appreciates in value undiminished by income
taxes;
• Trust distributions are later made to the beneficiaries
free of gift and estate tax.
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Other ILIT Advantages
• Besides providing funds for federal estate tax liquidity
an ILIT can address other personal and financial
needs of the grantor’s family including:
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–
–
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–
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Creditor protection
Special needs children
Educational needs
Wealth replacement
Multi generational management of assets
Non-tax estate liquidity needs
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Creditor Protection
• A ILIT can be designed to protect
beneficiaries who can not handle money
• Beneficiary’s creditors can not reach
assets in the trust
• Creditors can reach funds given to the
beneficiary
• Solution: The trustee purchases goods and
services for the beneficiary
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Special Needs Children
• A properly drafted ILIT may be used to benefit
a special needs child without causing a loss
of government needs based benefits (most
importantly Medicaid)
• This may be accomplished by including
language in the trust that subjects any
payments for the child’s benefit to the
trustee’s sole discretion.
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Estate Liquidity Needs
• Payment of Federal and state income
taxes due on IRA, 401K Plans
• State Estate Taxes
• Mortgages, car loans, personal loans and
credit cards
• Estate administrative fees
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Funding Educational Needs
• The cost of higher education has escalated
dramatically
• A ILIT can be used to provide grants to trust
beneficiaries for college, graduate school or
specialized training
– Cash value during the insured’s life if other
sources of funds are unavailable
– Death proceeds after the insured’s death
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Wealth Replacement
• Individuals thinking about making charitable
gifts especially of taxable IRA, 401K type
assets can replace a part of their inheritance
• Individuals can replace the value of property
through life insurance held in an ILIT for
multiple generations of their family
• Instead of receiving real property and the
problems that may go with it the children will
receive cash (income tax free)
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Multi-Generational Management
Of Assets
• Many states have changed the rules limiting
how long trusts may last.
• Trusts may now be sited in jurisdictions that
will benefit multiple generations as a form of
family bank for medical, educational and
other needs.
• An opportunity for the advisor team to work
with the family for multiple generations.
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Amending Existing ILITs
• Sale of trust assets to new trust
• Assignment of trust property by Trust
Protector/Trustee
• Trust Decanting
• Trust Protector
• Merger
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Existing ILITs
• Trust owned Life Insurance (TOLI)
• Most TOLI has no servicing producer
• Most professional trustees have no guidelines
for handling TOLI or making asset allocations
on Variable Universal Life (VUL) policies
• Most non-professional trustees have not
reviewed their policies in the last 5 years and
have no procedures for asset allocation on
VUL policies
•
Asset allocation does not assure a profit or protect against a loss in a
declining market.
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Policy Audits
• Life insurance whether individually
owned or trust owned should be
regularly reviewed from two
perspectives:
– Is the policy appropriate to current
needs?
– Is the policy performing as originally
illustrated?
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Is the policy performing as
originally illustrated?
• Separate account products
– During the 1970s companies developed
products that placed investment decisions
and risk in the hands of policyholders
– Cash values and death benefits are tied to
the selected investments’ performance
Guarantees are based on the claims-paying ability of the issuing
insurance company.
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Original assumptions, still apply?
• During the mid-80s some UL policies were
illustrated at 12% or higher
• Current lower crediting rates mean that many
policies will not perform as illustrated
• Some companies have raised the cost of
insurance
• Lower dividend scales require more term in
blended arrangements to maintain total death
benefits
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Performing the Analysis
• Request an in-force ledger and using the:
– current premium
– current interest rate
– current insurance charges, and
– current policy values
• Illustrate values to determine if the policy will
perform as originally illustrated, and
• Determine will the policy perform as currently
needed?
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Remedial Choices – Old Policy
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Keep the policy as is – may lapse
Increase premiums
Reduce the face amount
Surrender or replace the policy
Utilize non-forfeiture values
Sell the policy
Note: These choices entail diverse tax consequences that the
policy owner should take into account.
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New Policy Considerations
• New types of policies, options, riders and
guarantees may be available to improve the
policyholders situation
• Improvements in underwriting, expense
management and life expectancy may mitigate
in the policyholders favor
– Same face, lower premium
– Higher face, same premium
Guarantees are based on the claims-paying ability of the issuing insurance
company.
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Replacement - if the existing
coverage should be replaced
consider
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Tax consequences
Surrender charges
New contestability periods
Insured’s health
Changes in the insured’s tobacco use, occupation
and hobbies
(Under most circumstances, a policy owner is best advised to follow IRC
Section 1035 rules when replacing a policy.)
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Questions?
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