8th Sep 2014
Many years ago when estates larger than $650,000 could be subject to Federal estate taxes, everyone and their uncle had an irrevocable life insurance trust (ILIT). For those of you not familiar with the ILIT, it is an irrevocable trust that holds an insurance policy on the life of the grantor. The grantor makes premium payments as gifts to the beneficiaries. To make the gifts present interests, and help keep the insurance proceeds out of the grantor’s estate, the trustee gives the beneficiaries a notice (called a Crummey notice after a famous tax case) allowing the beneficiaries to withdraw the premiums gift. When the beneficiaries don’t withdraw their funds, the premium is paid and everyone is happy.
The thinking then, and still for some estates now, was that this was the best way to protect family assets from taxes. The cash from the trust could be used to purchase assets such as a business, real estate, or family heirlooms from the estate. This gave the estate ready cash to pay taxes without having to literally sell the family farm. Why then have these gone out of fashion? Tax reforms have changed the landscape. Estates in 2014 must be larger than $5,340,000 in order to be possibly taxable on the federal level. A barrage of states has repealed their estate and inheritance taxes. These changes mean that for many the old reason, easy cash for payment of taxes, just isn’t a need for them anymore.
So why would you still use an ILIT? First, if you are unlucky enough to live in one of the 19 states with an estate or inheritance tax, it may still be a necessary old style part of your planning. For the rest of us, ILITs can be used in a variety of ways that are very beneficial.
Take the example of Joe. Joe owns a successful business worth about $4,500,000 but not much else. He is a widower with three children, one of which is his right-hand woman in the business. The other two kids are successful in their own right, but have nothing to do with the business. Joe wants to leave the business to the daughter running it with him, but wants to be fair to the other kids. Enter the ILIT. Joe can leave cash without bumping his estate into the taxable range to the other two kids while leaving the business to the daughter working in it.
Charitable planning can be achieved through an ILIT as well. Mr. and Mrs. Jones own multiple rental properties, several farms, and their estate is just a bit over taxable size. They know their church will really need some additional property in a few years and they would like to help them out. At the same time, Mr. and Mrs. Jones don’t want to leave their kids in the lurch either. So they leave some of their farm properties to the church which will lower their estate below the taxable level. Then they establish an ILIT to get cash to their kids to replace value of the farms and give some liquid assets to help manage those rental properties. Win for the charity and the kids!
Many of the tried and true estate planning tools are still applicable to today’s landscape. Let us work with you to discuss whether an ILIT is ideal for your estate goals.