Photo of Henry Ford founder of the Ford Foundation
By Melvin J. Howard
An Irrevocable Life Insurance Trust is a Trust established by the grantor to
hold or own insurance policies on the life of the grantor/grantors. This applies to US residents only. In Canada all proceeds from life insurance policies are tax free. By retaining no control over the Trust those proceeds are not considered part of the grantors
estate for federal estate tax purposes. For example, a $1,000,000.00 insurance policy owned by the decedent at the time of death will incur federal estate tax of between $370,000.00 and $550,000.00.
The same policy owned by the Trustee will incur no federal estate taxes. (Note:
there is a three year recapture of policies transferred by the decedent to the
Trustee. New policies purchased by the Trustee are not subject to recapture).
Even the transfer of a $100,000.00 policy will save at least $37,000.00 in
federal estate taxes.
The greatest advantage of the irrevocable life insurance trust is, of course,
the potential tax-free appreciation between (a) the relatively small amount of
dollars paid as insurance premiums plus any gift tax cost, and (b) the tax-free
proceeds received from the insurance policy upon the estate owner's death.
Another important advantage is that the trust receives the tax-free proceeds the
very moment the estate owner's estate taxes accrue. The trustee can use the
proceeds to lend money to the insured's estate or to purchase assets from the
estate, and thus provide the funds needed to pay Federal estate tax and state
death taxes. The significant point, of course, is that the funds used to pay the
death taxes are not themselves included in the insured's taxable estate.
Often, the use of these funds makes it possible to keep the family business in
the family. The trustee can purchase stock in the corporation or make a short
term or long term loan to it. With the assurance that these tax-free funds will
be available when needed, there is a comfortable feeling among the parents and
the children that the business will continue down the line.
The gifts of the money to the trust to pay the premiums on the insurance policy
will be subject to gift tax, because they are gifts of "future interests." There
is, however, a reliable way to use $10,000 of the annual gift tax exclusion for
each beneficiary. It is called the Crummey power, named after an important court
opinion. Under this arrangement, the donor makes a gift to the beneficiary of
the trust estate and provides in the trust that he or she has 30 days to
withdraw the gift. If he or she does not draw the gift down within that time,
then the option lapses and the property remains in the trust free of gift tax.
If the estate owner wishes to have his estate continue for two or more
generations and if his and his wife's estates exceed $3,000,000, the trust makes
it possible to avoid the confiscatory 55% generation skipping tax (GST). There
is a highly technical point, however, that must be scrupulously observed. When
the estate owner contributes the amount of the insurance premium to the trust,
he must not use the GST annual exclusion. Rather, he must each year use a small
part of his $1,000,000 lifetime GST exemption. The reason is that, to use the
annual exclusion, the donor must give it to the trust beneficiary in such form
that it will be taxable in the beneficiary's estate.
The trust instrument must have certain provisions regarding the investment of
trust funds in insurance policies on the estate owner's life or on the life of
any person in whom a beneficiary has an insurable interest. These powers should
be included in the trust instrument with the other investment powers.
If it is contemplated that the trustee will purchase stock of the family
corporation or make loans to it, there should be both a detailed section
regarding the trustee's powers and the exoneration of the trustee from any
losses resulting from its exercise of these powers.
Another paragraph should cover the trustee's power to purchase assets from the
insured's estate or the spouse's estate at fair market price.
There are a variety of ways the insurance premiums can be paid. All of the
following have been used in the decided cases:
1. Direct gifts of money to pay the premiums.
2. A pre-authorized right to the trustee to withdraw funds from one of the
insured's bank accounts.
3. A pre-authorized right to the trustee to withdraw funds from one of the
family corporation's bank accounts. Presumably, the amounts withdrawn would be
treated as loans to the insured stockholder-officer. The loans should be
evidenced by promissory notes bearing the customary interest rate.
