15.6 Irrevocable Life Insurance Trust

• Library: A Lawyer's Guide to Estate Planning: Fundamentals for the Legal Practitioner (ABA) (2018 Ed.)

15.6 Irrevocable Life Insurance Trust

If a client has an estate that may reach or exceed the maximum estate exclusion amount, life insurance may create an estate tax problem. Once estate taxes are owed, the tax rate is a flat 40%. The death benefit of life insurance is taxable the same as other estate assets, but the life insurance can be excluded if owned by a third party, such as, a trust.

The trustee must apply for the life insurance on the life of the husband. The trustee will then both own and be the beneficiary of the life insurance proceeds. The premiums also will be paid by the trustee. Normally, income-producing property is not transferred to the trust because the transfer constitutes a taxable gift; thus, the trustee has no funds with which to pay the premiums. The husband can make annual gifts to the trust with which the trustee can pay the premiums. If the trust is structured as a Crummey trust, the gift of the premiums qualifies for the annual gift tax exclusion. Thus, no gift tax will be owed for the gift, which otherwise would be a future-interest gift for which the annual exclusion would not be available. On the death of the husband, the life insurance proceeds will be paid to the trustee, and no estate tax will be owed on the proceeds. For a further discussion, see Chapter 5, at 5.25, and Chapter 8, at 8.42. Two helpful ABA publications are L. Brody et al., The Irrevocable Life Insurance Trust Forms and Drafting (3d ed.; ABA, 2011) and L. Mezullo, An Estate Planner's Guide to Life Insurance (2d ed.; ABA, 2009).

IRREVOCABLE TRUST AGREEMENT FOR WIFE AND CHILDREN

This Agreement is made the __________ day of __________, 20___, by __________ hereinafter called the Settlor, and XYZ BANK AND TRUST COMPANY, of Madisonville, Kentucky, hereinafter called the Trustee.

? Comment: An insured who holds power in a fiduciary capacity and acts as a trustee of this type of trust may be deemed to possess incidents of ownership in the life insurance policies, thus causing the proceeds to be included in his or her estate. To avoid any possibility of this disastrous result, it is wiser to use a corporate trustee for this type of trust. If not possible, the spouse or a third party can act as trustee. In no event can each spouse serve as trustee for the other spouse's life insurance trust. The IRS considers such an arrangement reciprocal trusts and includes the insurance in the insured spouse's estate, thus defeating the tax savings.

ARTICLE ITrust Property

The Settlor hereby assigns, transfers, and delivers to the Trustee, its successor and assigns, the property set forth in Schedule A to be held and administered in trust, for the following uses and purposes:

ARTICLE IIRights in Policies of Insurance

The Trustee is hereby vested with all right, title, and interest in and to any policy or policies of insurance transferred to the Trustee, and is authorized and empowered to exercise, for the purposes of the trust herein created, and as absolute owner of such policy or policies of insurance, all the options, benefits, rights, and privileges under such policy or policies, including the right to borrow upon such policy or policies and to pledge such policy or policies for loan or loans. The Settlor hereby relinquishes all rights and powers in such policy or policies of insurance and will, at the request of the trustee, execute instruments reasonably required to effectuate this relinquishment.

? Comment: This paragraph merely clarifies—with some redundancy—that the settlor-insured possesses no incidents of ownership in the life insurance policies that are owned by the trustee. This paragraph is more important in situations in which existing policies are transferred by the settlor-insured to the trustee, rather than when a new policy is purchased by the trustee on the life of the settlor-insured. If existing policies are given to the trustee, the value of those policies must be obtained from the various insurance companies because the value is a taxable gift to the extent it exceeds any annual exclusions that are available.

ARTICLE IIIPayment of Premiums

The Trustee may apply for and purchase insurance policies on the life of the Settlor and shall pay the premiums on such policies first from trust income, if any, and if none, from trust principal, and to allow any such policies to lapse. If the trust assets are insufficient to pay such premiums, the Trustee shall be under no obligation to pay any premiums which may be due. Further, the Trustee shall have no obligation to notify any person of the nonpayment for such premiums or seek to have any other person pay such premiums.

? Comment: This paragraph clarifies the premium payment obligations of the trustee, as well as the action to be taken if the policy premiums are not paid.

ARTICLE IVWithdrawal Rights During Insured's Lifetime

During the insured's lifetime and immediately following any contribution to the trust, each of the Settlor's then-surviving children shall have the unrestricted right to withdraw (in cash or in kind) an amount equal to such child's proportionate share of any such contribution. A child's proportionate share shall be the amount of such contribution divided by the number of the Settlor's children surviving at the time of the contribution. Each child's right of withdrawal shall not exceed in any one calendar year five thousand dollars or five percent of the value of the principal of the trust as of the end of such calendar year, whichever shall be the greater.

This right of withdrawal is noncumulative and shall lapse thirty calendar days following the date of the contribution, but no later than the last day of the calendar year in which the contribution is made. If any child predeceases the insured, such child's...