What is an ILIT?

You may have heard the term, or seen the acronym, “ILIT” and wondered what is an ILIT?  It refers to an Irrevocable Life Insurance Trust, and it can be a very valuable estate planning tool.  An irrevocable trust holds all rights to the transferred property to the trust itself, without the grantor retaining a right to revoke the trust, or materially modify its terms. When an irrevocable trust is used for a life insurance policy, it becomes an ILIT.

How do you fund an ILIT?

An irrevocable life insurance trust can either be funded or unfunded.  If the trust is funded, that means the grantor transferred the life insurance policy to the trust, along with other funds or property, from which the premiums for the policy are to be paid.  The down side to a funded ILIT, is that the trust’s income may be taxed.

However, if the ILIT is unfunded, there is no additional property included in the trust.  Instead, the grantor makes annual gifts to the trust to pay for the insurance premiums.  This is the most common way of funding the ILIT.  The down side is that those gifts are not qualified for the annual gift tax exclusion, because they convey future interests to their intended beneficiaries.

How to use a “Crummey Power”

If you have not heard of a “Crummey Power,” you may be missing out on a very useful estate planning tool.  A Crummey Power can be used to make the annual gift tax exclusion apply to the gifts made to an ILIT to pay premiums.  The Crummey Power allows beneficiaries the option to withdraw annual cash transfers.  They are not required to make withdrawals, but the mere fact that they can, makes the annual transfers into present interest gifts, which qualify for the annual gift tax exclusion.  However, Crummey Powers lapse after a period of time, if no withdrawals are made.  At that time, the excess funds become taxable.

Power of Appointment

There is a way to protect the excess funds that are left when Crummey Powers lapse.  By giving the beneficiaries of the trust the testamentary power of appointment over the excess funds, those beneficiaries can designate, in their own estate plans, who should receive those funds.  Using these tools can help to reduce tax liability, if used properly.  It is important to discuss these options with your estate planning attorney.

Separate Trusts for each beneficiary

You can also create a separate trust for each beneficiary of the insurance policy.  That way, each beneficiary is entitled to receive distributions from the trust during his or her lifetime.  Then, when the beneficiary passes away, the estate receives the remaining trust property.  This is another way to avoid the lapse of the Crummey Powers, because all of the property ultimately goes to the beneficiary or his or her estate.

If you have questions regarding irrevocable trusts, or any other estate planning needs in Fayetteville, please contact Sexton, Bailey Attorneys, PA online or by calling us at (479) 443-0062.