The primary question the potential trustor has to make is whether it is worth losing control, either direct or indirect, over the trust property or income. After all, the regulations included in the Internal Revenue Code govern closely the provisions of an ILIT.
Smart Business spoke with Sherry Maynard of J.J.B. Hilliard, W.L. Lyons Inc. to learn more about the benefits of ILITs and why they are gaining in popularity.
What is an Irrevocable Life Insurance Trust?
An ILIT is a legal arrangement in which one individual or institution controls property given by another individual for the benefit of a third party. It provides life insurance when a certain event is triggered, usually due to the demise of the trustor.
The trustor cannot purchase the policy. A third party has to purchase the insurance for the policy owner, after which a trustee oversees the trust. The trust can be created from scratch, or existing life insurance policies can be transferred into it, which is something trustors must consider carefully. The life insurance proceeds of trustors who die within three years of the date of the transfer are taxed as part of their estates.
What are the advantages of an ILIT?
The major advantage for the heirs is that they will receive a sizable inheritance from the life insurance, and they will not have to take on a financial burden. The advantage for the trustor is intangible: the ILIT provides peace of mind in the knowledge that heirs are well taken care of and assets are protected.
Who typically owns an ILIT?
Generally, it is people with large assets who realize that taxes will be owed after their death, which can place a burden on their heirs. For example, a business owner has a large amount of acreage that is appreciating rapidly, which will result in a tax liability. The ILIT is a way of providing the funds to pay the taxes on the asset. Money left over after the taxes are paid goes to the heirs, since there is no maximum face value for the life insurance policy.
Other ILIT owners might be the proprietors of family businesses who want to make sure that management is uninterrupted should they become too old or ill to run the business themselves.
An ILIT might be worthwhile for an individual whose net estate, including life insurance, exceeds the estate tax exemption of $1 million, or for a married couple whose net estate is more than both spouses’ exemptions of $2 million.
Who should business owners work with to set up an ILIT?
The best qualified people to consult include tax attorneys who specialize in estate trusts and financial planners. The planners evaluate the clients’ assets, ascertain their long-term goals, assess their tax liabilities, and determine how an ILIT can be created to protect their assets.
It is important to remember that ILITs cannot be set up without the involvement of tax attorneys, financial planners and other advisers. That is because the trusts have to be monitored continuously by a third party to make sure they conform to changing tax laws and comply with IRS guidelines and federal and state laws.
What role do financial advisers play in setting up and maintaining ILITs?
They become the trustors’ custodians after the attorneys design the irrevocable trusts. They send out what is called a ‘crummy letter’ to advise beneficiaries that the trustor has made a gift to them. Once the beneficiaries refuse the gifts - which is generally the option they choose by default - the trustee reinvests the declined funds to pay for the insurance policy and remits them to the insurance company.
As mentioned earlier, heirs have the option of refusing the monetary gifts given by the policy owner. Although beneficiaries can accept the funds, it is not in their best interests to do so, since it would defeat the purpose of the ILIT. If the beneficiary declines the gift, the trustee reinvests the funds to pay for the insurance policies.
It is nuances like these that make financial advisers integral parts of the ILIT process.
SHERRY MAYNARD is a financial consultant, Chartered Financial Analyst and Chartered Wealth Advisor with J.J.B. Hilliard, W.L. Lyons Inc in its Columbus branch office. Reach her at (614) 210-6284 or firstname.lastname@example.org.