ILIT funding: Do I transfer my existing life insurance?

Posted: Wed Jan 20, 2010 03:29 pm Post Subject:

Yes, but there are few caveats. First, any cash value of the policy will be considered a gift to the ILIT; you don't really want to go beyond the gift tax exclusion amount, which currently is $13,000. Keep in mind you also need "room" to gift the premium to the ILIT for payment.

The agent's suggestion to buy a new policy isn't without merit though. Assuming you currently own the policy you are placing inside the ILIT, you'll have a 3 year period before the IRS will consider you being a non owner and allowing the benefit paid if you die to be excludable from your gross estate. If on the other hand, you gift premium dollars to the ILIT and have the trustee establish a new policy on your life, you will never have had "ownership" of the policy and will not have to satisfy any three year look back.

If you'd like, elaborate more on why you are asking question about establishing an ILIT, and we'd be happy to give you additional guidance.

Posted: Wed Jan 20, 2010 04:18 pm Post Subject:

I agree with BNTRS. Some more information would be helpful though. However, I will add that the gift tax exclusion amount is $13,000 per beneficiary within the trust, and both husband and wife can gift the amount. So if you have one beneficiary, you could gift up to $26,000 without eating into your lifetime maximum gift tax exclusion (which is $1 million). If you have three beneficiaries, you could gift up to $78,000 per year, etc. If you are not married or the spouse is deceased, it would be $13k times the number of beneficiaries. The answer to the following questions would help:

1. How long is your current policy guaranteed for?

2. How long do you want to keep the coverage?

3. Does your current policy have any cash value?

3. Is this a second-to-die policy for estate planning purposes? If not, what is the reason for putting the policy into the ILIT?

Posted: Wed Jan 20, 2010 05:50 pm Post Subject:

It might make sense, but we don't have enough information.

BNTRS mentioned one of the problems if death occurs too soon. However, this problem can usually be solved simply by buying some "extra" insurance (cheap term) for 3 years.

Posted: Thu Jan 21, 2010 09:56 am Post Subject:

hi dgoldenz,

What's this second-to-die policy?

If you are not married or the spouse is deceased, it would be $13k times the number of beneficiaries.

Posted: Thu Jan 21, 2010 03:15 pm Post Subject:

Second to die policy is a policy that pays a death benefit upon the second spouse's death, but is held jointly by both spouses. It's used primarily for estate planning purposes where there will be an estate tax issue and the plan is to essentially transfer all assets to the surviving spouse and then probate the estate upon the second spouse's death--this is when an estate tax would be due.

It's quite cheaper than both spouses having ILITs and funding them to buy life insurance on both their lives.

However, there is a strategy for estate tax purposes that would suggest probating both estates and splitting the assets between the spouses. This would require less life insurance since estate taxes would be less. It would also allow both spouses to use their estate tax exemption instead of just one. It's a tad more complicated. There are insurance products out there that will allow an insured to named another insured and give them the right to purchase have insurance purchased on their own life upon the death of the original insured.

So the chain of events that would take place under the second strategy (without using second to die insurance) would be: spouse 1 dies, death benefit paid, part of death benefit goes towards buying new life policy on spouse 2's life, spouse 1's 50% of the assets are sent to estate and remaining life insurance proceeds can be lent to the estate to help pay for remaining estate tax liability after spouse 1's exemption has been used up. Then when spouse 2 dies, there is a funded ILIT ready to take care of remaining estate tax liability after spouse 2's exemption has been used up. Again the strategy seeks to make less of an estate tax liability and as a result a lower insurance need/cost. It's an interesting idea, but I've never personally seen it work out all that well.

The $13k gift limit per beneficiary is a federal law so yes, applicable to all 50 states. You can give anyone you want a $13k gift per year without dipping into your lifetime gift credits.

Posted: Thu Jan 21, 2010 04:18 pm Post Subject:

BNTRS, it does not make sense to use a 2nd to die policy the way that you are describing it for estate planning purposes. Let's say that it is a $5,000,000 policy and the combined federal and state rate is 50%. You have just increased their estate by $5,000,000 at the second death and increased the estate tax by $2,500,000.

The way that it is typically done is that an ILIT will be the owner and beneficiary of the insurance policy. This way, the $5,000,000 will be out of the estate and be income and estate tax free.

I can't see any advantage to a second to die policy being jointly owned instead of being owned by the ILIT.

Posted: Thu Jan 21, 2010 09:02 pm Post Subject:

Yup poor choice of words, jointly held = jointly insured but owned by ILIT.

So to be clear about the process. Gift premium dollars to ILIT, have trustee purchase Second-to-Die policy on spouses. First spouse dies, not much happens (some have riders that change premiums or waive premiums for a little while, or even pay up policies), second spouse dies death benefit is paid into ILIT where it avoids estate taxability. Beneficiaries of ILIT can then use ILIT proceeds to lend money to the estate to pay estate taxes.

Posted: Thu Jan 21, 2010 09:20 pm Post Subject:

Good fix!

Posted: Fri Jan 22, 2010 09:02 am Post Subject:

He's explained and suggested that I'd need to buy a new life insurance policy.

Posted: Fri Jan 22, 2010 09:58 pm Post Subject:

If there's no ILIT, there's no point in applying. Too many possible problems.