Chapter 30 - § 30.1 • INTRODUCTION AND OBJECTIVES OF AN IRREVOCABLE LIFE INSURANCE TRUST (ILIT)

• Jurisdiction: Colorado

§ 30.1 • INTRODUCTION AND OBJECTIVES OF AN IRREVOCABLE LIFE INSURANCE TRUST (ILIT)

§ 30.1.1—Introduction

An irrevocable life insurance trust (ILIT) is a device that is intended to make proceeds of life insurance policies available to trust beneficiaries in a manner that will not subject the policy proceeds to unnecessary estate, gift, or generation-skipping transfer (collectively "transfer") taxes, or income tax.¹

An ILIT creates a new legal "person" to own the policy for tax purposes. The trust will usually, though not necessarily, be created by the person or persons whose life or lives are insured. Although the transaction may be easily implemented so that the trust is valid and effective under state law, accomplishment of the tax objectives requires tax expertise along with careful drafting.

To constitute a trust, an arrangement need only take the form of a fiduciary relationship in which one person holds the title to property subject to an equitable obligation to hold or use the property for the benefit of another. G. Bogert & G. Bogert, Law of Trusts 1 (Rev. 2d ed. 1984). As a general rule, and in Colorado, a writing is not necessary to create a trust holding personal property; however, the desired tax and estate planning objectives of an ILIT can be assured only if the terms of the trust are set forth in a written trust instrument. (C.R.S. § 38-10-106 requires a writing for a trust concerning real property.) As this chapter will demonstrate, an adequate trust instrument must properly address fairly sophisticated tax issues.

It would be ideal if the tax objectives could be met without the settlor having to relinquish the power to revoke or amend the trust or retain trust benefits or control. Unfortunately, this cannot be done, and the trust must be irrevocable. Although it may be unlikely that a trustee or beneficiary would pursue a course of action that would be against the reasonable wishes of a settlor, there can be no legal obligation or ongoing power exercisable by a settlor to control the otherwise lawful actions of trustees.

An ILIT best serves individuals with projected taxable estates in excess of the client's unused "applicable exclusion amount" as defined in I.R.C. § 2010(c) ($11.58 million for decedents dying in 2020). For married persons, the rule of thumb is twice the applicable credit amount. If structured properly, the ILIT can provide support, liquidity, and wealth replacement to family members free of transfer and income tax. Improperly structured or implemented, the device can trigger unnecessary transfer and income taxes and effectively double the cost of insurance for the net benefit.

ILITs are tax-driven creatures, and the following discussion concerns mostly tax issues. At the same time, non-tax issues, such as the powers, duties, and rights of trustees and beneficiaries under state law and the design of various dispositive provisions, cannot be ignored.

§ 30.1.2—Objectives of ILITs

ILITs can accomplish a number of objectives. Although not an exclusive list, several examples are provided below.

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