| Alan R. Horvath, Attorney at Law |
| Frequently Asked Trust Questions |
| Phone: 209 754-5291 Fax: 209 754-5293 |
| ahorvathlaw@sbcglobal.net |
P.O. Box 81
596 Mountain Ranch Rd.
San Andreas, CA 95249
596 Mountain Ranch Rd.
San Andreas, CA 95249
What is an irrevocable life insurance trust?
The purpose of an Irrevocable Life Insurance Trust, or ILIT is to enable you to leave a gift at your death that is not
part of your taxable estate. Depending upon your circumstances, an ILIT is either a brilliant piece of legal work, or
overkill.
To start with, your taxable estate consists of everything you own or control at your death. If you buy a policy on
your own life, the proceeds are part of your taxable estate at your death since you as owner could have at any time
cashed out the policy and you controlled the beneficiary. On the other hand, if someone else owns a policy on
your life, they pay the premiums, and they control the beneficiary, the proceeds at your death are not part of your
estate.
For example, if you own a policy on your life with your son as beneficiary, the proceeds are part of your estate at
your death. However, if you give your son each year, the money to pay premiums on a policy on your life which he
owns and controls, the proceeds at your death are not part of your estate. There is potentially much more to this
as is explained below, but the basic issue of what is or is not in your estate at your death is that simple.
It is worth noting that at this level, there is nothing special about life insurance. Your choice of investment vehicle
should be driven by your own needs and preferences. The estate planning objectives are independent of the
investment choices. So, for example, if you put $5,000 into a stock fund for your son each year, but you retain
control over the fund, when that fund gets distributed at your death through your will or trust, it will be subject to the
estate tax. However, if you gave your son the $5,000 each year and he accumulates it, no part of it is in your
estate at your death.
BUT!!
There is also a gift tax. Gifts you make during your life are also subject to tax for anything over a lifetime
cumulative total of $1,000,000. If your personal situation is such, that your reaction to the above statement is "I
should be so lucky!", then you don't have to worry about the gift tax. Period.
There is also an annual per recipient exclusion which is currently at $13,000. This is why most of us, most of the
time don't worry about the gift tax. Even the IRS recognizes the insanity of everyone having to keep track of every
time they give anything to anyone. So, in the above examples, even if you are lucky enough to have to worry about
exceeding the life time cumulative gift tax exclusion, you could give your son the premiums on a policy or the funds
to invest each year, and avoid both gift tax and estate tax as long as the annual amount was less that the current
annual exclusion.
So why do you need a trust at all?
The concern which gives rise to the trust is this. What if you give your son the funds to invest in either a premium
or stocks, and he just takes a trip to Vegas? The purpose of the trust is to take the funds out of your control,
sufficiently to escape being in your estate at death, but still keep them within the control of some rules and
guidelines, that you have established, to insure that they are in fact invested for the long term.
At this point it gets tricky. The lifetime cumulative gift tax is applied to ANY gift. It does not matter whether the
recipient gets to enjoy it now or only later. The only thing that matters is that you have given up ownership and
control. However, the annual exclusion applies only to current gifts. Meaning gifts that the recipient can currently
enjoy. So your trust not only needs to prevent your son from squandering the money before he is supposed to get
it, but it needs to be worded so that your annual contributions will still satisfy the IRS requirements for a current gift.
At this point, you get yourself an attorney.
The purpose of an Irrevocable Life Insurance Trust, or ILIT is to enable you to leave a gift at your death that is not
part of your taxable estate. Depending upon your circumstances, an ILIT is either a brilliant piece of legal work, or
overkill.
To start with, your taxable estate consists of everything you own or control at your death. If you buy a policy on
your own life, the proceeds are part of your taxable estate at your death since you as owner could have at any time
cashed out the policy and you controlled the beneficiary. On the other hand, if someone else owns a policy on
your life, they pay the premiums, and they control the beneficiary, the proceeds at your death are not part of your
estate.
For example, if you own a policy on your life with your son as beneficiary, the proceeds are part of your estate at
your death. However, if you give your son each year, the money to pay premiums on a policy on your life which he
owns and controls, the proceeds at your death are not part of your estate. There is potentially much more to this
as is explained below, but the basic issue of what is or is not in your estate at your death is that simple.
It is worth noting that at this level, there is nothing special about life insurance. Your choice of investment vehicle
should be driven by your own needs and preferences. The estate planning objectives are independent of the
investment choices. So, for example, if you put $5,000 into a stock fund for your son each year, but you retain
control over the fund, when that fund gets distributed at your death through your will or trust, it will be subject to the
estate tax. However, if you gave your son the $5,000 each year and he accumulates it, no part of it is in your
estate at your death.
BUT!!
There is also a gift tax. Gifts you make during your life are also subject to tax for anything over a lifetime
cumulative total of $1,000,000. If your personal situation is such, that your reaction to the above statement is "I
should be so lucky!", then you don't have to worry about the gift tax. Period.
There is also an annual per recipient exclusion which is currently at $13,000. This is why most of us, most of the
time don't worry about the gift tax. Even the IRS recognizes the insanity of everyone having to keep track of every
time they give anything to anyone. So, in the above examples, even if you are lucky enough to have to worry about
exceeding the life time cumulative gift tax exclusion, you could give your son the premiums on a policy or the funds
to invest each year, and avoid both gift tax and estate tax as long as the annual amount was less that the current
annual exclusion.
So why do you need a trust at all?
The concern which gives rise to the trust is this. What if you give your son the funds to invest in either a premium
or stocks, and he just takes a trip to Vegas? The purpose of the trust is to take the funds out of your control,
sufficiently to escape being in your estate at death, but still keep them within the control of some rules and
guidelines, that you have established, to insure that they are in fact invested for the long term.
At this point it gets tricky. The lifetime cumulative gift tax is applied to ANY gift. It does not matter whether the
recipient gets to enjoy it now or only later. The only thing that matters is that you have given up ownership and
control. However, the annual exclusion applies only to current gifts. Meaning gifts that the recipient can currently
enjoy. So your trust not only needs to prevent your son from squandering the money before he is supposed to get
it, but it needs to be worded so that your annual contributions will still satisfy the IRS requirements for a current gift.
At this point, you get yourself an attorney.
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