Chapter 30 - § 30.4 • GENERATION-SKIPPING TRANSFER TAX AND ILITS

• Jurisdiction: Colorado

§ 30.4 • GENERATION-SKIPPING TRANSFER TAX AND ILITs

§ 30.4.1—Generation-Skipping Transfer Tax — Generally

Settlors of ILITs often wish to transmit wealth to successive generations of beneficiaries. When more than two generations are involved, Chapter 13 of the Internal Revenue Code will come into play and may exact a third transfer tax, the generation-skipping transfer (GST) tax. The purpose of the GST tax is, with some exceptions, to tax transfers at each generation. Because of the concept of "leverage," ILITs can be effective GST planning devices. The specifics of the GST tax are covered by other chapters of this Handbook. Below are some key GST tax issues as they relate to ILITs.

§ 30.4.2—Leveraging

The most unique aspect of GST tax as it relates to the ILIT is the opportunity for significant leverage of the GST exemption amount. This is because the allocation of GST exemption to an ILIT is based on the premiums paid, and not the death benefit, assuming the grantor timely elects to allocate the grantor's GST exemption amount to the ILIT.

To illustrate the benefits of this technique, assume that the grantor has an $11 million life insurance policy inside an ILIT, and that the annual premiums are $50,000 a year. If the grantor allocates GST exemption to the trust every year for four years, the grantor would have used $200,000 of the grantor's GST exemption amount. If the grantor passes away in the fourth year (2020), the entire $11 million would be exempt from GST tax for future generations, and the grantor would still have approximately $11,400,000 (GST exemption amount less $200,000) left of GST exemption to allocate to additional assets going to the grantor's family. If the grantor did not allocate any GST exemption to the annual premiums, then upon the grantor's death, the grantor would have to allocate almost his or her entire GST exemption to the ILIT. To compare the two scenarios: under the first, a total of $22,400,000 would be GST exempt, while under the second, only approximately $11,600,000 would be GST exempt.

However, there is a risk in allocating the GST exemption amount to an ILIT. If at some point the life insurance policy is allowed to lapse, the grantor would have wasted a significant portion of the grantor's GST exemption. As a result, it is not typically recommended that a grantor allocate any GST exemption amount if the insurance policy is a term policy, unless the policy is a...