Most affluent people buy life insurance within a vehicle called an Irrevocable Life Insurance Trust (ILIT). Typically the insured(s) is the grantor and the children are the beneficiaries of the trust. The selection of the trustee is a very big decision and one of the most important steps in the establishment of the trust, as that person or entity has the fiduciary responsibility to follow certain steps so that the trust is in compliance with ILIT rules.
The reasons for selecting an ILIT are many, but it is only effective if the ILIT is structured and managed properly. When this is the case, an ILIT becomes a wonderful and effective tax-leverage strategy. The trustee within an ILIT should monitor the following procedures:
- _____ The trustee should apply for and own the policy by following a credible application and underwriting process. The grantor should never sign as owner or anything other than the insured prior to the establishment of the trust.
- _____ Premiums should be contributed by the grantor to the trust utilizing an annual gifting strategy. Once premiums are received by the trust, the trustee then notifies the beneficiaries of the trust that a gift has been made on behalf of the beneficiaries. The beneficiaries are then given a limited period of time to withdraw their portion of that gift, or the right to make a withdrawal lapses. The trustee then pays the premium to the carrier.
- _____ All premiums should be paid by the trustee to the carrier from the trust checking account.
- _____ The grantor should retain proof of the gifts contributed to the trust. The trustee should retain a copy of referenced notices above along with proof that those notices were sent.
- _____ The trustee should request an in-force ledger at least every two years to determine whether the policy still meets trust objectives; then they should follow our process (or one that is similar) for policy review. The trustee should retain all materials pertaining to these reviews to provide proof of fiduciary due diligence.
If the above procedures are followed, the desired tax leverage (gift, estate, and income tax) should be attained.
The desired tax leverage is based on the death proceeds. These proceeds should be payable to the trust without any income or gift taxation and should be excluded from the decedent’s estate for estate tax purposes.