Just ILIT: the popularity of irrevocable life insurance trusts.

• Author: Fukuto, Erin S.
• Position: Estateplanning

One of the more popular estate planning techniques is an irrevocable life insurance trust (ILIT) to purchase and hold file insurance on the trust's grantors. When properly structured, such trusts remove the insurance proceeds front the estates of the insured and spouse for purposes of federal estate taxation. The use of an ILIT will assure that the grantor's estate will have sufficient liquidity to pay expected estate taxes, outstanding debts at death and provide cash to mitigate any identifiable financial risks.

However, a problem that more and more taxpayers are encountering as they use this estate planning technique especially with all the changes and uncertainties in estate and gift taxation, including the recent "fiscal cliff"--is a growing *inability to effiectively and tax-efficiently limd the payments of the tile insurance policy premiums within the trust on a year-to-year basis.

How ILITs Work

All insurance policies, insurance proceeds and any other assets held by the ILIT are Considered to be owned by the trust and not a part of the grantor's, or surviving spouse's. Federal gross estate. Upon the death of die insured, the life insurance proceeds and other trust assets will not be subject to probate lees, creditor claims or, in some cases, state inheritance taxes.

Typically, the life insurance trust is structured as an unfunded trust, which holds only the insurance policies and no other assets. Such unfunded trusts are commonly set up as a "defective" irrevocable trust meaning that it will be treated as a grantor trust for tax purposes and any income will be reported and taxed to the grantor. For estate tax purposes, assets in the trust are considered gifted and not includible in tile grantor's estate.

As an unfunded trust, the grantor will normally make annual gilts to the trust so that it can pay the insurance premiums. The terms or the trust and the requisite creation If Crummey withdrawal rights the beneficiaries should be properly drafted so such gills will be eligible for the annual gift exclusion

Funding ILITs with Income Producing Assets

After an ILIT has been created, taxpayers run inn) situations where the Funds required to pay the insurance premiums significantly exceed their annual gift tax exclusion. In addition, the taxpayers may be perilously close to fully utilizing their lifetime gift tax exemption, which is $5.25 million for 2013. Or perhaps their estate planning needs and goals have changed and, as a result...