2890 N. Main Street, Suite 206 • Walnut Creek, CA 94597
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Irrevocable Life Insurance Trust

An Irrevocable Life Insurance Trust (ILIT) is commonly used to prevent the taxation of life insurance proceeds after the death of the insured person. Although life insurance proceeds are not subject to income tax, they are includable in the taxable estate of the insured. If the estate is large enough, up to 40% of the life insurance death benefit can be lost to federal estate tax. The solution is to purchase the policy using an ILIT or to gift an existing policy to an ILIT, so that the ILIT owns the life insurance policy, making the insurance proceeds estate tax free.

When you gift an existing policy to an ILIT, is the benefit realized immediately?

No. When you gift an existing policy to an ILIT, the policy must be in the ILIT for three years before it is excluded from your estate and not subject to federal estate tax.

Why must the trust be irrevocable?

In order to prevent the life insurance death benefit from being taxed, the insured person must relinquish control of the insurance policy. If the insured person could revoke the trust and take back ownership of the policy, then it would be treated as a taxable asset when the insured dies.

May the insured person serve as trustee?

No, the insured person must relinquish control of the insurance policy to a third party trustee.

Can you explain the annual procedure for paying the premium? 

The insured person under the policy should never pay a premium directly on either a new or existing trust policy.  All premiums should be paid by the trustee from a trust-owned bank account.  The insured usually makes sufficient cash gifts to the trust to allow the trustee to pay the premiums.  The gifts should go in the trust checking account, and the trustee should write and sign a trust check for the premium payment.  The insured must make the gifts early enough to allow the trustee to send out the (usually) 30 day “Crummey” notices. (A Crummey notice informs trust beneficiaries they can withdraw the gifted amount during a specified window of time.) The trust must have the cash resources available to meet the withdrawal rights of the beneficiaries, even if they are unlikely to exercise the right.  If the insurance policy has enough accessible cash value, or if other trust assets in sufficient amounts are available, then the early timing of the grantor’s gift is not necessary.

Do I really need to open a new ILIT checking account to do this?

There is no question that the best practice for the trustee of an ILIT is to open a new checking account owned by the trustee and under the new EIN obtained for the ILIT when the trust was created.

I received an annual premium reminder notice from the insurance company.  What next? 

Hopefully before you got the notice, the grantor of the ILIT deposited the funds needed to pay the premium in the ILIT checking account.  If that did not happen this year, make a note to get it done in advance next year.  Notify the grantor of the trust, who is also the insured of the trust, that the premium is due.  The grantor will then deposit funds from his/her individual account as opposed to a joint account, particularly if the other account holder is a beneficiary of the ILIT (such as a spouse).

Now you send out the Crummey notice to the individuals who are beneficiaries of the trust.

Can you explain Crummey notices?

The Crummey notices are used when money is put into a life insurance trust.  The Crummey notice goes to the beneficiaries of the life insurance trust, unless there is a provision in the ILIT that allows notice to go to a third person, or a particular beneficiary has been exempted by the donor from the notice. These notices inform beneficiaries they can withdraw the gifted amount during a specified window of time – which is usually 30 days.

Why do we have to do Crummey notices?

Crummey notices bring up another tax issue – the gift tax. When the insured gifts money to the ILIT, this is treated as a taxable gift to the beneficiaries of the trust (usually the children). Fortunately, there is an annual exclusion against the gift tax, which exempts the first $14,000 of taxable gifts each year to any beneficiary. But the annual exclusion is only available if the beneficiary actually has an unrestricted opportunity to take outright ownership of the gift, rather than let it be used for payment of premiums. This is called the “present interest rule.”  By giving Crummey notices, the courts have held that the beneficiaries of the ILIT do have a present interest in the gift made to the ILIT.  This enables you to avoid filing gift tax returns for gifts of $14,000 or less.

What should the Crummey notice say? 

Very basically, a Crummey notice says, “A gift has been made to a trust of which you are the beneficiary and you have the right to take out some percentage of the gift for the next 30 days.”  In doing this the notice should include, at least, (i) the amount subject to the withdrawal right, (ii) the expiration date for the withdrawal right, and (iii) the manner in which the withdrawal right may be exercised.

What do I do after sending out the Crummey notices?

If the time for the beneficiary to withdraw the money has expired without the beneficiary exercising his or her right, you will then pay the premium from the funds in the trust account.

2890 N. Main Street, Suite 206
Walnut Creek, CA 94597

925.943.2740

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