How life insurance can present estate planning complications - III

In a series of ongoing posts, we've been exploring how those who take the responsible step of securing a life insurance policy should strongly consider creating an irrevocable life insurance trust or ILIT.

To recap, the advantages of an ILIT are that its creation will serve to remove the life insurance policy from a person's taxable estate, meaning their estate taxes will be lower given that the size of their overall estate will technically be smaller. Furthermore, it enables a person to ensure that the proceeds of the policy are distributed in accordance with their exact wishes.

One of the questions to naturally arise in the context of ILITs is who should be appointed to serve as trustee, meaning who will essentially manage the trust and distribute its assets as directed.

The simple answer is that virtually any trusted person or entity -- sibling, parent, family friend, bank, etc. -- can play the role of trustee. What's more significant for our purposes, however, is who should not serve as trustee.

In general, if you (and your spouse) are the insured parties under the life insurance policy owned by the ILIT, you probably don't want to serve as trustees. That's because there's a good chance that if you do, the Internal Revenue Service will determine that the life insurance policy never actually left your estate. As such, it will be included as part of your estate, such that your estate tax liability could be significantly greater than you envisioned.

As for the specific responsibilities of the trustee of an ILIT, they include just some of the following:

  • Paying annual insurance premiums using money you transfer to the ILIT
  • Sending beneficiaries annual notification (i.e., "Crummey Letter")
  • Filing annual tax returns
  • Distributing policy proceeds upon your passing

We'll continue examining more basic background information about ILITs in future posts. In the meantime, if you have any questions regarding estate planning or other elder law concerns, please consider speaking with an experienced legal professional.

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