Creating and Reviewing ILITs
The irrevocable life insurance trust (ILIT) has been a useful estate planning tool for several generations. However, given the constantly changing tax environment and the developments in both estate planning techniques and insurance products, it is important to periodically review your client’s ILIT to confirm that the rationale for creating the trust is still valid, that the trust as written still meets the needs and expectations of the client, and that the underlying insurance policy is performing in the manner contemplated at purchase. New clients may also have a need for an ILIT that needs to be discussed fully prior to the drafting of the instrument and purchase of the life insurance product. Here are some thoughts to consider in conducting such a review.
Much discussion has surrounded the new estate tax exclusions, eliminating the estate tax for the majority of Americans. While providing for liquidity to pay estate taxes without having to liquidate other assets was one of the principal reasons for estate planners to recommend creation of an ILIT, your client may now feel that the need no longer exists as, under the current law, they don’t have a taxable estate. It might be wise to remind the client that tax laws can be changed whenever Congress feels the need, and five years from now we could have a completely different tax code. Obviously, once a policy funding an ILIT is allowed to lapse, it cannot be reinstated and the client will have to purchase new insurance that will probably be more expensive because of their increased age and changes in medical conditions.
Estate tax liquidity is not the only reason for establishing an ILIT. Frequently, equalization of inheritances among children due to the transfer of a family business to one or more of those children could be addressed by the liquidity that the trust provides. Periodic reviews of the client situation (sale of the business or the children’s having a change of heart) may prompt a reexamination of the value of the ILIT to the client.
Major changes in a family situation frequently highlight the necessity of an ILIT review. A disabled beneficiary’s receipt of government benefits may be jeopardized by an ILIT’s lack of special needs provisions. Because the trust is irrevocable, use of one of the progressive decanting statutes permits the insertion of protective language in the resulting trust necessary to continue receipt of government benefits. The same is true if the client didn’t initially consider creditor protection of the beneficiaries, divorce of the beneficiaries, or other particular problems of a beneficiary such as drug or alcohol abuse that could be mitigated or relieved by changes in the dispositive scheme of the trust through decanting. A particular jurisdiction’s non-judicial and judicial modification statutes may also provide the intended result short of decanting the trust.
A periodic review of the life insurance company issuing the policy and the actual performance of the policy should also be conducted. The strength of an insurer should be assessed to confirm the company is delivering the right balance of low premiums and high credit ratings to give the client confidence the company will be in business when the time comes for the death benefit payment. The insurance policy that forms the basis of the trust should be analyzed for performance, particularly in the case of universal life policies. The advisor should review the investment selection and the guaranteed, stated and actual performance of the policy, and, if underperforming, look into replacement with a new policy using a tax-free exchange, assuming the original policy is at least five years old.
The best way for the client to ensure that all the legal and tax requirements of an ILIT are met is to use a professional trustee. The duties of an ILIT trustee include collection and remittance of insurance premiums in a timely manner, preparation and transmission of Crummey letters to beneficiaries and recordkeeping, preparation and filing of any required gift or income tax returns, and, after funding of the trust with the life insurance proceeds, administration of the trust and proper exercise of discretion in making distributions to beneficiaries, with faithful adherence to the specific terms of the trust. Most individuals, particularly family members, do not have the expertise to perform these duties and subject themselves and their personal assets to liability in the event of a breach of trust.
In summary, while ILITs are integral components of many estate plans, it is important to periodically review and assess these trusts to ensure they are meeting your client’s expectations and family situations.
Mainsail Family Trust Contacts
Sandra Nesbit, CES, CDFA | Principal
Ashley Vice, CFA, CFP® | Family Wealth Advisor
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