An Irrevocable Life Insurance Trust With All the Ingredients for Success*

As we've recently been discussing, Irrevocable Life Insurance Trusts (ILITs) are very powerful estate planning tools.  Unfortunately, they often fail  because people do not follow the particular rules necessary for them to succeed.  In addition, there are gift and estate tax consequences to be considered.  In this issue, we want to review with you a Private Letter Ruling (200404013) from the Internal Revenue Service about an ILIT that passed all tests with flying colors.

The Trust
The Basics: A husband created an Irrevocable Life Insurance Trust.  The husband funded the trust with shares of an S corporation, along with other assets.  The Trustees of the trust were his wife, along with a Corporate Co-Trustee.  The beneficiaries of the trust were the couple's children.  The distribution provided that upon the death of the husband, the trust would divide into separate trust shares for each child.

The Insurance: The trust then purchased a survivorship life insurance policy on the lives of the husband and wife.  The policy was purchased with the assets already inside the trust.  Ten annual premium payments were to be made, all with assets in the trust.  There would be no additional contributions to the trust by the husband or wife.

The Distribution: The sub-trusts created for each child, upon the death of the husband, would pay quarterly to each child the net income of their respective trust share.  The remainder assets will be kept in trust and distributed at the discretion of the trustee for care, health, education, maintenance, or support.

The Key Ingredients
The legal, financial, and tax advisors who participated in the creation of this trust really took the time to think through the variety of rules that impact this type of planning.  Some of the key strategies they implemented that allowed this trust to succeed are as follows:

1. The wife, as Co-Trustee of the ILIT, executed a written document denouncing her right as trustee to:
     a. Change the beneficiary of the policy
     b. Revoke any change of beneficiary
     c. Assign the policy
     d. Revoke any assignment of policy
This result was the avoidance of incurring incidents of ownership, which would have caused the amount of the life insurance to be included in the husband's estate.

2. The husband renounced any right to make contributions to the trust and to appoint a successor advisor.
This resulted in avoiding a gift tax problem.

3. The husband funded the trust, but had his wife consent to treat the gift as a split gift.
This resulted in doubling the amount allowed to be gifted without incurring gift tax liability.

4. Sufficient Generation-Skipping Tax exemption was allocated to the trust to result in zero inclusion ration for GST tax purposes.

The Payoff
This strategic approach allowed this ILIT to avoid any gift tax liabilities.  The proceeds of the policy were not included in either the husband's estate or the wife's estate.  The trust also has a zero inclusion ratio for GST tax purposes.  Most important, this trust accomplished the goals of the clients:

1. To leave money to their children in a way that is protected from creditors and potential divorces;
2. To leave money to their children in a leveraged manner; and
3. To utilize strategies to reduce their estate tax liability.

This is a great example of how the strategic planning of advisors can help clients accomplish their goals!

*Adapted from the Planning Partners Press.