TRUST & ESTATE PLANNING

Act Now to Preserve the Estate Tax Benefits of Your Life Insurance Trusts

10.07.2021 - Gerard F. Joyce, National Head of Trusts and Estates

The tax proposals currently under consideration in Washington stand to have a major impact on irrevocable life insurance trusts (“ILITs”).  We don’t have a crystal ball as to whether these proposals will become law; but if they do, it could mean that life insurance proceeds received by an ILIT would be included in your estate for estate tax purposes.

This potential impact is significant enough that, even though the proposals are not a done deal, we recommend reviewing any ILIT that is part of your estate plan immediately. The proposed changes would be effective when the laws are enacted, so your window to act may only be a handful of weeks.

How ILITs Save Estate Taxes

The irrevocable life insurance trust has been a mainstay of estate planning for wealthy families. If you create and administer an ILIT properly, life insurance proceeds received by the trust are not included in your estate for estate tax purposes when you die.   

For example, if your ILIT owns a policy with a $5 million death benefit on your life, the trust beneficiaries would receive the $5 million free of estate tax when you die. In contrast, if you owned the policy in your own name, the $5 million insurance proceeds would be subject to a 40% federal estate tax, leaving your beneficiaries with only $3 million.

How the Tax Proposals Would Take Away the Estate Tax Benefits of ILITs

The current tax proposals would undo the estate tax benefit of creating an ILIT. An ILIT that is created after the new laws are enacted would be included in, not excluded from, your estate for estate tax purposes. In addition, even for existing ILITs, any future contributions to the trust including future premium payments would result in a portion of the trust being subject to estate taxes. 

For example, let’s imagine you have an existing ILIT that holds a $5 million life insurance policy. Each December, you and your spouse make a $30,000 gift to the trust. Then, in January, the trustee uses the $30,000 to pay the premium on the policy and keep the policy alive. Under current tax rules, this is a standard arrangement. 

If the tax proposals become law, this standard arrangement becomes problematic. Come December, you may have a dilemma.  If you contribute to the trust as you normally do, a portion of the trust will become subject to estate taxes. If you don’t make your regular gift to the trust, there may be no funds in the trust to pay the premium due in January and the policy may lapse.

You may be inclined to think having a part of the trust included in your estate is not too bad. Yet it’s not clear how the IRS will calculate the portion of the trust to be included in your estate. In addition, the economics of your life insurance policy may not hold up if a portion of the policy proceeds will now be subject to estate tax.

Options to Consider

If you have an ILIT, start by reviewing your policies and the goals for your trust. There may not be a clear solution for the future administration of the trust, but you will only discover that on examination. 

Options to consider include:

  • Make a contribution to your ILIT now to pay future premiums and other expenses. The current proposals would only impact your ILIT if there are future contributions. If you can fund the trust now in an amount sufficient to avoid the need for future gifts to pay premiums and other expenses, the new proposals may not be a concern. Of course, for some this may be easier said than done. You may need to make a taxable gift or pay gift tax. You may also need to raise cash or sell other investments.
  • Plan to restructure your life insurance policies. If the current proposals become law, you could plan to restructure your policies. This could involve conversion to a paid-up policy with guaranteed benefits. The trustee of an ILIT alternatively might in some circumstances consider cashing out a policy. Of course, these changes may not make sense for many policies. That will depend on the policy’s terms and general economics.
  • Plan to lend money to the ILIT. Rather than contribute funds to the trust in the future, you could lend money to the trust to pay premiums and expenses. The concern with a loan is ensuring that it has economic substance and is properly administered going forward. The trust will need to make interest payments. The IRS could also scrutinize whether the trust is an appropriate borrower, given its only asset may be the life insurance policy.
  • Plan to distribute the policy to the ILIT beneficiaries. If permitted by the trust terms, the trustee might terminate the ILIT and distribute a policy to the trust beneficiaries. If future premium payments are necessary, you can make gifts directly to the beneficiaries. This would remove the protections of the trust. Some families might consider placing policies in a partnership or other entity to maintain consolidated ownership.
  • Plan to let the policies lapse. In some cases, it may be appropriate to let a policy lapse. This could make sense if you judge future premiums to no longer be worth the benefits if the trust is included in your estate.
Guidance on What’s Best for You

There are pros and cons with each of these options, and your Fiduciary Trust team can help you gather the information you need to review and decide the path that make sense for you.    




This communication is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

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Gerard F. Joyce, National Head of Trusts and Estates

Theresa A. McGinley, Director of Trust Administration and Trust Counsel

Bryan Kirk, Director of Estate and Financial Planning and Trust Counsel

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