Generational Wealth: Irrevocable Life Insurance Trusts
What if there were a way for you to create an estate for pennies on the dollar that could benefit heirs for generations to come, free from the claims of creditors? Sound too good to be true? Well, not quite.
The irrevocable life insurance trust (ILIT) is a vehicle for creating and preserving family wealth. Like other trusts, it involves a grantor, a trustee and one or more beneficiaries. An ILIT is formed by having your attorney draft a trust document and by contacting your insurance agent to apply for life insurance. It’s the life insurance that makes it possible for anyone to create a family fortune.
Typically, during the grantor’s lifetime the trust is unfunded — the only asset is the life insurance. Because no income is generated by the trust, generally, you make gifts to the trust sufficient to enable the trustee to pay premiums. Also, because there is no trust income and the only trust asset is the life insurance cash value, it’s unlikely that any distributions will be made during life.
Following the insured’s death, the trustee collects and invests the life insurance proceeds. Provisions in the trust determine how income and principal are distributed. Although most states have laws that limit the number of years that a trust may endure, usually the lifetime of living beneficiaries plus 21 years, a few states allow the trust to continue for as long as you like.
If the trust is properly established, assets should be outside the reach of both the grantor’s and the beneficiaries’ creditors.
As good as this all sounds, it gets even better when the tax consequences are considered. With a little planning, the trust can be created and funded free of gift, estate, generation-skipping and income taxes.
Gift Taxes
Your payment of premiums on a policy owned by an ILIT is considered a gift for gift-tax purposes. But if the trust is properly drafted, a gift of premium payments to the trust should qualify for the gift-tax annual exclusion. This means that you can gift up to $15,000 (in 2020) in premiums per beneficiary each year without tax being imposed on the gift. To qualify for the annual exclusion, the gifts must be made to the trust, and the beneficiaries must be given the power to withdraw the gifts from the trust for a limited period of time. Most beneficiaries don’t have to be told that they’ll be better off in the long run by not touching the gifts.
Estate Taxes
Federal estate tax laws change and are phased in and out. Because of this uncertainty it makes sense to guard the ILIT against the federal estate tax. As a general rule, so long as the trustee is owner and beneficiary of the policy from the outset and you do not possess any incidents of ownership (rights to exercise control or receive benefits) in the policy, the death proceeds are excluded from your estate.
Generation-Skipping Taxes
Like the estate tax, the generation-skipping tax has been phased in and out phased out over the years. This particularly onerous tax applies to transfers to beneficiaries who are more than one generation removed from you, such as grandchildren and great-grandchildren. The tax is in addition to estate and gift taxes, and the flat rate is whatever the highest estate-tax rate happens to be 40 percent in 2020.
The good news is that you currently have an exemption that can be allocated as you wish. By allocating the exemption to gifts used to purchase life insurance by the ILIT, you may exempt the trust assets from generation-skipping taxes for as long as the ILIT lasts.
Income Taxes
Finally, the death proceeds should be free of income tax when received by the ILIT (pursuant to IRC 101(a)). That’s one of the advantages of life insurance over other assets. The appreciation on other assets you give away during life is subject to income or capital-gains taxes when your heirs sell them.
The bottom line is that the ILIT is not only a way to create a long-term, creditor-exempt family fortune, it’s a way to do it free of income and transfer taxes.
If you’re healthy enough to qualify for life insurance and want to create a legacy that can benefit heirs for years to come, the ILIT may be a good way to go.
Provided by courtesy of Aaron Jousan Johnson, Managing Director with JCAP Group in Darien, CT.
Our firm does not render legal, accounting or federal or state tax advice. Please consult your CPA or attorney on such matters.
The accuracy and completeness of this material are not guaranteed. The opinions expressed are those of the author(s) and are not necessarily those of JCAP Group, J. Capital, or its affiliates. The material is distributed solely for informational purposes with no fee and is not a solicitation of an offer to buy any security or instrument or to participate in any trading strategy.
