Santa Clarita Estate Planning and Living Trusts Lawyers - Understanding Life Insurance Trusts

Understanding Irrevocable Life Insurance Trusts

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Irrevocable Life Insurance Trusts (ILITs) are planning tools used to keep life insurance proceeds outside of the taxable estate. If your estate is too large (that definition changes every so often per Congress), then your estate may own significant estate taxes. Part of what makes an estate too large is life insurance proceeds - a fact often overlooked by people who simply think they don't have enough money to worry about estate taxes.

If the couple has any "incidences of ownership" in the policy, it will be included in the estate.

Enter the Irrevocable Life Insurance Trust.

Attorneys draft Irrevocable Life Insurance Trusts. The trust will apply for its own Federal Tax ID number. The trust will then apply for the survivorship life insurance policy. It will be the applicant, owner and beneficiary of the policy.

Using something called "The Crummey Letter:"

Typically, the life insurance premiums are paid by the parents in the form of annual gifts to the Irrevocable Life Insurance Trust. Currently a person can give up to a certain amount each year to as many people as they want without paying gift tax or having the amount subtracted from their lifetime exclusion. However, these gifts must be "present interest" gifts, which mean the recipient must have immediate rights to the gift.

Gifts to an ILIT, for paying premiums on a life insurance policy owned by the ILIT, are not "present interest" gifts. One way to do this is by using a "Crummy" letter. A "Crummey" letter qualifies the gift as a "present interest" gift. The letter takes its name from a court case initiated in 1968 by Clifford Crummey, who was trying to do this very same thing: make annual gifts present interest gifts. The outcome of the case required the use of a letter, now known as the "Crummey" letter.

A letter is sent every year to each of the beneficiaries of the ILIT. It simply states that a gift has been made to the ILIT and they can withdraw it if they want within a certain timeframe. If they don't exercise this right, the gift becomes a present interest gift.

Obviously, there is an "understanding" between the parents and children to ignore these letters, as it is a part of the overall estate plan.