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This memorandum is designed to outline some of the basic administrative steps to be followed by the Trustee of an irrevocable life insurance trust (hereinafter referred to as an “ILIT” or the “Trust”).  When properly implemented and administered, an ILIT prevents the imposition of estate tax on any life insurance policies owned by the Trust, both at the insured’s death and at the death of the insured’s surviving spouse.[1]  If you have established or are acting as Trustee of an ILIT, we recommend that you follow the procedures outlined below to maximize the effectiveness of the Trust.

INITIAL STEPS

1. Transfer Policy or Policies to Trust and Designate Trust as Beneficiary. At the time the Trust is executed, the insured should also execute the forms necessary to transfer ownership of the selected insurance policies to the Trust.  The insured should also complete the forms necessary to designate the Trust as the beneficiary of those policies. Each life insurance carrier typically has their own forms, however they generally request the same items, such as the Insured, the Trustee, and the Trust’s identifying information[2]. The end result is that the Trust owns the life insurance policy and is named as beneficiary of the policy.

The forms needed to change the owner and beneficiary in this manner are available from the appropriate insurance companies or, in the case of insurance policies issued through a corporation (such as group life insurance), through the insured’s employee benefits office.  The insured should obtain the forms before the date that is set for execution of the Trust and forward them to us to assist with their completion. 

When completing the forms, we recommend that you refer to the Trust as follows:

Mary Jones, Trustee, and her successors in trust, of the John Jones 2024 Irrevocable Insurance Trust under Agreement dated January 1, 2024.

Occasionally, time pressures result in creation of the Trust before all the insurance company forms are available.  Please keep in mind that only those insurance policies transferred to an ILIT more than three (3) years prior to the death of the insured will achieve the intended exemption from estate tax.  This three (3) year “waiting period” does not start until the formal transfer of ownership to the Trust has been completed.  Therefore, prompt and proper transfer of ownership of the insurance policies to the ILIT is extremely important.

If a new insurance policy is to be obtained either in connection with the creation of the Trust or at some later time, the Trust itself generally should be the initial applicant for, owner of, and beneficiary of the new policy.  Beyond eliminating the need to transfer ownership of the policy to the Trust, this approach will prevent the insurance proceeds from ever being considered a part of the insured’s estate, even if he or she dies within three (3) years after the Trust purchases the new insurance.     


[1] Provided, however that the insured life survives for a term of three (3) years after the transfer of policy ownership to the Trustees of the Trust. 

[2] At the time the Trust is executed, we will obtain a Tax Identification Number for the Trust.


2. Verify Insurance Company Records. Approximately three (3) months after the creation of the Trust and the transfer of the insurance policies to the Trustee, the Trustee should request written verification from each insurance company that the company’s records reflect the following: (1) the Trust is the sole owner of each policy issued by it transferred to the Trust, and (2) the Trust is designated as sole beneficiary of each policy and will receive the proceeds in a single payment, and (3) that premium notices will be sent directly to the Trustee.

ONGOING TRUST ISSUES

1. Payment of Premiums May Be a Gift to Trust. As discussed above, each time a premium payment is due, the insured may make a gift to the Trust (to be added to the Trust checking account, paid by check to the Trustee, or paid directly to the company) sufficient to pay the premium. The Trustee will need to mail letters notifying the beneficiaries of this gift and should do so before using the gifted funds at least 30 days in advance of the actual premium due date. Generally, the ILIT provides that certain Trust beneficiaries have an immediate right to withdraw any gifts made to the Trust. These withdrawal rights are necessary to qualify gifts to the Trust for the “annual exclusion” for gift tax purposes.  Using this mechanism, a donor can contribute to the Trust up to $18,000 (in 2024) per beneficiary annually (reduced by other gifts to those beneficiaries) without the imposition of any federal gift tax.  If the donor’s spouse consents to have the gift treated on the donor’s gift tax return as made one-half by the donor’s spouse, this exclusion can be increased to up to $36,000 with respect to each person having a right of withdrawal.  This number will rise in the future.  Under most trust agreements, each beneficiary’s withdrawal rights will lapse at the rate of the greater of $5,000 or 5% of the value of the trust each year, which prevents adverse gift tax consequences to the beneficiary if he or she does not exercise the withdrawal rights.  The withdrawal rights may become cumulative to the extent the rights exceed such thresholds each year.  The Trustee should keep careful records in order to determine the amount of withdrawal rights from time to time.

The creation of the Trust should be discussed with the Trust beneficiaries who are eligible to make withdrawals, and the Trustee should send a confirming letter to each of them and retain a copy in the Trust files.  Although it is not required, the letter should provide the dates of all future premium payments and the amounts of the annual contributions to the Trust.  Please see Exhibit “A” for an example of what such a letter might look like.  It is not clear under existing law whether a letter providing “one-time” notice is sufficient, or conversely whether notice must be given each time an insurance premium is paid or a contribution is made to the Trust.  The conservative approach thus would be to give each beneficiary notice on each occasion.  In this case, the initial letter should be thorough in explaining the withdrawal rights (see Exhibit “A” for an example), but subsequent letters can be more brief (see Exhibit “B” for an example).  Please note that the attached letters are intended for adult beneficiaries.  If there are minor beneficiaries, the letter should be addressed to that beneficiary’s legal guardian, normally either of his or her parents (but not the insured).

Even though the Trust beneficiaries normally will choose not to exercise their withdrawal rights, the rights are legally enforceable and must be treated as such by all the parties.  For example, there must be no agreement between the grantor of the Trust and the beneficiaries that the beneficiaries will not exercise their withdrawal rights.  If the parties to the Trust do anything to undermine the enforceability of the withdrawal rights, gift-tax benefits for contributions to the Trust may be lost.  In addition, Trust beneficiaries who do not wish to exercise withdrawal rights should not affirmatively decline or waive those rights; they should merely allow them to expire.

2. Tracking Payments of Premium and Gifts Made to Trust.  There are multiple methods and strategies for making premium payments and tracking gifts to the Trust. 

  • Trust Checking Account.  Unless the Trust holds only employer-provided insurance or other insurance with respect to which the Trustee will not be required to pay premiums and will not receive dividends, the Trustee may wish to open a checking account in the name of the Trust.  The Trustee will need to provide the banking institution with the name of the Trustee and Trust, the date of the Trust, and its tax identification number. This account can then be used as the basic trust management vehicle.  The Trustee can deposit any cash gifts to the Trust into the checking account and can pay insurance premiums and other Trust expenses from the account.  In this way, the Trustee will preserve a permanent record of Trust transactions in the event that they need to be submitted to the IRS.  If there are two or more Trustees, the account can be structured so that only one Trustee’s signature is required on checks. 
  • Alternative Payment Methods of Premium.  If the Trustee wishes to avoid establishing a separate Trust checking account, some practitioners advise that premium payments may be paid in the following manners: 

Payment by Check to Trustee.  The insured may forward a check to the Trustee, made payable to the Trustee in the amount of the premium, within a reasonable period of time (at least 30 days) in advance of the premium due date.  The Trustee should then send notification letters to each of the Trust beneficiaries and hold the check during the 30-day period.  When the premium payment is due, the Trustee should endorse the back of the check as follows:

“Pay to the order of ABC Life Insurance Company.” [Signed:]  John Doe, Trustee

This approach avoids the need of opening a checking account for the Trust and has been sanctioned by a number of judicial decisions.

Payment Direct to Company.  An insured may pay a premium by gift directly to the insurance company.  In such a case, the premium payment is treated as a gift to the Trust.  Similar to the utilizing a Trust bank account, the Trustee should send notification letters to the Trust beneficiaries in advance and wait the requisite thirty (30) days.  If the notice requirements are not met, this method may increase the likelihood that the IRS will seek to deny gift tax “annual exclusions” for the premiums paid.  Nevertheless, this result is utilized by many clients and certainly should be preferable to allowing a policy to lapse for nonpayment of premiums.

3. No Contributions from Spouse.  Furthermore, if the insured’s spouse is a beneficiary of the Trust, no contributions by the spouse should be made to the Trust and no premiums should be paid out of either a joint account or an account in the spouse’s individual name.  Failure to follow this important rule could result in all or a portion of the life insurance proceeds being subject to estate taxation at the surviving spouse’s death.

4. Additional Contributions to Trust.  ILITs generally are designed for the primary purpose of administering life insurance. Often special dispositive and administrative provisions are included in the governing document.  The Trust, therefore, may not be a suitable vehicle for administration and disposition of assets other than insurance, at least during the insured’s lifetime.  Specifically, for tax and administration reasons, an independent Trustee or co-Trustee may be needed if gifts made to the Trust are larger than needed to pay premiums and other expenses.  In addition, if surplus funds are invested or if the Trust’s checking account is an interest-bearing account, the Trust may begin to collect taxable income, requiring the Trustee to file annual tax returns.  Your Wiggin and Dana attorney or other tax advisor should be consulted before making such gifts to the Trust.

5. Gift Tax Return for Persons Making Contributions to the Trust.  A Gift Tax Return may need to be filed for any year in which a gift is made to the Trust.  Gifts to an ILIT are generally designed to qualify for the $18,000 per donee annual exclusion from gift tax.   Remember that all gifts from a donor to a donee (in trust or otherwise) must be combined to determine if the $18,000 threshold has been met.  Remember also that (1) the cash value of any existing life insurance policies added to the Trust, and (2) the premiums paid by an insured’s employer on policies owned by the Trust count as a gifts when determining the total taxable transfers to the Trust for that year.

If only gifts that qualify for the annual exclusion are made in a given year, it generally is not necessary to report these gifts on a gift tax return.  However, it still may be necessary to file a gift tax return if a donor wishes to allocate any of his or her lifetime exemption from the Generation-Skipping Transfer Tax (GST Tax) to any gifts made during the year.  In addition, there are very highly technical default rules relating to automatic allocation of GST Tax exemption, which may require many taxpayers to file gift tax returns for the sole purpose of electing not to have these automatic rules apply.

If the explanations contained above and in the following section of this memorandum do not clearly address the facts of your situation, you should consult your Wiggin and Dana attorney or tax advisor about the necessity of filing gift tax returns.  Such returns are due on April 15 following the year in which the gift is made.

6. Allocation of Generation-Skipping Tax Exemption and Gift Tax Returns. The Generation-Skipping Transfer Tax (GST Tax) generally applies when you make a gift to persons two or more generations younger than you (for example, your grandchildren) or to trusts for their benefit.  You have an $13,610,000 exemption from this tax (in 2024), which you may use either during life or at death.  If you elect to use the exemption during your life, you generally report this election by filing a Federal gift tax return by April 15th.

If you have made gifts to a trust which you intend to qualify for exemption from the GST Tax, it may be necessary to file a gift tax return to report this election.  In other cases, automatic allocation default rules contained in the tax law may make it unnecessary to file such a return.  Finally, in certain circumstances, these default rules may automatically allocate GST Tax exemption to gifts to some trusts generally not intended for GST Tax planning.  In such cases, application of these default rules could result in a waste of GST Tax exemption.  Typically, in consultation with your accountant or Wiggin and Dana attorney, it makes most sense to elect out of allocating GST to transfers made to an ILIT.

Unfortunately, the default rules are too numerous and too complex to adequately summarize in this format. Accordingly, you should make certain that you discuss the need to file gift tax returns either with your Wiggin and Dana attorney or with a tax preparer who is aware of these automatic GST Tax allocation rules and is familiar with the intent of your estate planning.

7. Trust Income Tax Returns. An ILIT generally will be treated as a “grantor trust” for income tax purposes, which means that the grantor (and not the Trust itself) is liable for the payment of tax on any income generated by the Trust.  Among other reasons, a trust is a “grantor trust” when (1) trust income may be used to pay the premium on insurance policies on the grantor-insured’s life, or (2) the terms of the trust permit trust income to be distributed to the grantor’s spouse.  Because most ILITs are funded only with insurance, generally no income, deductions, or credit will be generated, and thus the Trust will not have any filing requirements.  However, if assets are added to the Trust that produce items of income, deduction or credit, these items will have to be reflected on the income tax return of the grantor.  The Trustee should then consult his or her tax advisor about obtaining a tax identification number for the Trust and to discuss filing requirements.

8. Loans Against Insurance Policies Held in the Trust. Insurance policies transferred to an ILIT may be subject to outstanding loans.  Also, the Trustee generally is authorized by the Trust agreement to borrow funds from the insurance company and to pledge the Trust policies as security.  This technique can be used to pay all or part of the premiums due on certain types of policies.

9. Special Characteristics of Employer-Provided Life Insurance. If the premiums on any insurance policies held in the Trust are paid by the insured’s employer (“group life insurance”), in part or in whole, the IRS has taken the position that while employment continues such payments are considered (1) taxable income to the employee, limited in the case of group life insurance to the premium attributable to coverage in excess of $50,000, and (2) as gifts by the employee to the trust owning the policy.  Depending on the terms of the governing trust, Treasury rulings indicate that the $18,000 annual gift tax exclusion may be available for such “gifts” to the trust.  The desirability of continuing the Trust after retirement of the insured requires consideration before his or her retirement.

10. Termination of the Trust. Many ILITs contain provisions that permit the termination of the trust and distribution of the policies during the insured’s lifetime.  If you are contemplating such a termination, please be sure to consult counsel.  This opportunity MUST be reviewed shortly before retirement in the case of group life insurance policies.

11. Death of the Insured. Upon receipt of notice of the death of the insured, the Trustee should request appropriate claim forms from the insurance company, its local agent, or the broker who services the Trust policies.  Payment of the proceeds normally takes several weeks.  When the proceeds are collected, the problems of administering the Trust will be substantially increased, both with respect to investment responsibility and record keeping.  The Trustee should consult with counsel at that time.

When the insurance claim is filed, the Trustee should request that the insurance company forward directly to the insured’s Executor a Treasury Department “Form 712” for each policy collected.  Form 712 is a statement of the policy’s value that the Executor must submit to the IRS (attached to the U.S. Estate Tax Return), whether or not the policy proceeds are taxable.

The ILIT may provide for the appointment of a co-Trustee at the death of the insured.  If so, the co-Trustee should be notified immediately of the insured’s death, and a meeting should be arranged among the Trustees and their counsel to discuss further administration of the Trust.

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U.S. Treasury Circular 230 Notice:  Any U.S. federal tax advice included in this memorandum is not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal tax penalties.

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