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Modern Uses For Life Insurance Trusts

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Since the enactment of the Tax Cut and Jobs Act of 2017, the utility of the irrevocable life insurance trust (ILIT) has been in question. The substantial increase in the federal estate tax exemption–$11.4 million for an individual and $22.8 million for a married couple in 2019-greatly reduced the need for estate planning aimed at lessening federal estate tax liability or offsetting estate taxes for many clients. As a result, many clients may be wondering if an ILIT is necessary.

An ILIT Can Still Be a Helpful Planning Tool

Depending upon a client’s particular goals and circumstances, an ILIT can still be a useful planning tool. As with all financial planning, a qualified planner should help clients to reassess their goals for both the present and the future, and provide targeted guidance about how the ILIT may be able to meet estate and financial planning needs. There are several factors that should be discussed in the planning:

1. Rapidly appreciating assets. Particularly for clients with a higher net worth, but whose current estates are valued below the federal estate tax exemption, it is important to examine the asset composition of the estate to determine if it includes assets that are likely to appreciate rapidly, potentially pushing the value of the estate over the federal estate tax exemption. Even if there is currently no estate tax liability, an ILIT may be needed if the estate includes an interest in a successful and growing business, real estate in a location with increasing property values, or other rapidly appreciating assets that may soon be at risk of generating an estate tax liability.

2. State estate taxes. Although Florida does not impose an estate tax, in 2019, 12 states and the District of Columbia have their own estate taxes. Consideration should be given to determine if an ILIT may still be a useful tool for mitigating or eliminating state estate tax liability.

3. Sunset of the current estate tax exemption. It is important to remember that the current federal estate tax exemption is not permanent. It may revert to the 2017 level of $5 million (adjusted for inflation) in 2026, only seven years from now. So ILITs that were needed prior to tax reform are likely to be needed again if Congress does not act to extend the current exemption amounts or make them permanent. So estate and financial planners should have planning discussions now to Discuss these possibilities with your clients and help them assess the exemption level they would feel comfortable planning for in their estate plan.

4. Protection against creditors. All 50 states and the District of Columbia have statutes that protect the death benefit or cash value of life insurance, and sometimes both, from creditors’ claims. In some states, however, the exemptions are limited to a specific dollar amount or to the amount reasonably necessary to support the beneficiary. In addition, although typically, the proceeds of the life insurance policy are never available to your client’s creditors because they pass to their beneficiaries without ever becoming part of their estate, some states have laws that limit the exemption only to certain beneficiaries, such as a spouse, children, or other dependents. Designating an ILIT as the direct beneficiary of their policy can be a strategy to protect proceeds that are outside the scope of the statutory exemption.

5. Protection against beneficiaries’ creditors. Although state law provides that the proceeds of life insurance policies are exempt (at least partially) from your client’s creditors, once those proceeds are in the hands of your beneficiaries, they typically are within the reach of their creditors. Even if your children or other loved ones do not currently have any creditors, they may eventually face lawsuits, bankruptcy, or divorce. If they are beneficiaries of your life insurance policy, the death benefit intended for them to receive may be exposed to claims from those creditors. As a result, designating an ILIT, rather than an individual, as the beneficiary of your life insurance policy may be a good option. If the trust is the owner of the proceeds, the creditors of the beneficiaries will not be able to reach the death benefit to satisfy their debts. An ILIT can also protect the death benefit through the inclusion of a “spendthrift trust” provision that prohibits trust beneficiaries from pledging the life insurance proceeds, which are an asset of the trust, as collateral. Their creditors are then only able to reach any distributions made to them from the trust.

6. Liquidity. If you have assets that are difficult to divide, for example, a business interest or the family home, a life insurance policy can provide liquidity that can be used to equalize an inheritance by providing cash to one or more children. Consequently, children who are not interested in the business will still receive an inheritance, and the family home will not need to be sold so the proceeds from the sale can be divided among the children. An ILIT is a good option under these circumstances because the insurance policy is beyond the reach of creditors.

What If the ILIT Is No Longer Needed?

If your ILIT was created primarily as a means of avoiding estate tax liability, and none of the factors mentioned above are major concerns, there are several strategies you, as the grantor of an ILIT, could use to extricate life insurance from an ILIT now viewed as unnecessary. For example, you could substitute cash of equivalent value for the life insurance policy in the ILIT or buy the policy back. Alternatively, the life insurance policy could simply be allowed to lapse by no longer providing funds for the premium payments, leaving the ILIT without any assets to manage. Policies that have cash value could be surrendered or sold in a life settlement transaction, and if the trustee has the discretion to do so, the cash could be distributed to the beneficiaries of the ILIT. It is also possible that the ILIT could be terminated pursuant to its own terms, with the consent of both the grantor and the beneficiaries, or through a court order requested by the beneficiaries.

We Are Here to Help

The best estate plans are the product of a team effort. Your financial and estate planning professionals can help you consider all the relevant factors to determine whether an ILIT will be beneficial for you and your loved ones. Through collaboration you can have your optimal estate plan designed for your individual circumstances.


Berlin Patten Ebling, PLLC

Article Authored by Christopher Caswell, Esq.

This communication is not intended to establish an attorney client relationship, and to the extent anything contained herein could be construed as legal advice or guidance, you are strongly encouraged to consult with your own attorney before relying upon any information contained herein.

All rights reserved. This copyrighted material may not be re-published without permission. Links are encouraged.

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