THE IRREVOCABLE LIFE INSURANCE TRUST - AATEELA

1 STEWART W. FLEISHER PRACTICE LIMITED TO ESTATE PLANNING, ATTORNEY-AT-LAW ADMINISTRATION, AND PROBATE MATTERS. )))))))))))))))))))))))))))))))))))))))) )))))))))))))))))))))))))))))))))))). WELLS FARGO BANK BUILDING PHONE (303) 488-9888. 3333 S. BANNOCK ST., SUITE 900 FAX (303) 488-9889. ENGLEWOOD, CO 80110. THE IRREVOCABLE life . INSURANCE TRUST . M ost clients are shocked to learn that the These clients have far less INSURANCE than death proceeds of their life INSURANCE is they think they have; or alternatively, subject to federal estate taxation. They they are paying far m ore for their believe that life INSURANCE escapes estate coverage than they should be paying. taxes and passes to their loved ones intact. The IRREVOCABLE life INSURANCE TRUST (or "ILIT" as it is frequently called) has This confusion probably began when the proven to be a highly effective method of client was told that life INSURANCE is avoiding estate taxes w ithout the many income tax-free.

2 For married clients, the problems transferring ownership of the confusion is compounded by the belief policy to the client's children or other that the unlimited marital deduction heirs. somehow magically insulates the client's death proceeds from ever being taxed. The ILIT has been tested extensively in court and an experienced estate planning Often the marital deduction merely attorney should have no trouble in postpones the heavy tax burden on such properly drafting this highly technical the death proceeds. document. The ILIT allows the taxpayer to control how the life INSURANCE Regardless of the source of this proceeds will be used to provide for his confusion, a great many clients will have or her loved ones. far less life INSURANCE proceeds than they The taxpayer can take full advantage of expect as a result of not plan ning for this all of the available $13,000 annual gift tax liability or using proper planning to tax exclusions to potential beneficiaries.

3 Avoid it. The ILIT allows the death proceeds to pass the taxpayer's loved ones free of For clients who have taxable estates estate taxes. (meaning, at the tim e of death, over $5,000,000 (2011) for single persons and An ILIT is a highly technical TRUST over $4,000,000 for married persons who document which is controlled not only by have implemented proper estate tax TRUST law, but also by the Internal planning), estate taxes will consume 35% Revenue Code and various regulations, of their life INSURANCE proceeds. rulings and court cases. 1. Nevertheless, if all of these technical as your spouse to exercise control over requirements are followed, the client the timing of when the proceeds upon her with a $1,000,0 00 life INSURANCE policy death will be distributed to your children. may save $450,000 in estate taxes w ith this important planning tool.

4 It is You (and often your spouse) cannot important that you understand these serve as trustee of the IL IT. The trustee requirem en ts before the IL IT is can be almost anyone else, such as a established. parent, a sibling, an adult child, or even a bank. PURPOSE: The purpose of this memo is to provide you with an overview of the You cannot be a beneficiary of the TRUST , nature of the IRREVOCABLE life INSURANCE but your spouse and children can be (and TRUST and what it can accomplish. usu ally are) beneficiaries. Quite often the ILIT parallels the dispositive Highlights of the IRREVOCABLE life provisions of your other estate planning INSURANCE TRUST which your client should docum ents, although there is no legal know: requirement for the ILIT to do so. BENEFIT: The proceeds from your life M oreover, the ILIT cannot be payable to INSURANCE are generally includible in your your estate or to your revocable living taxable estate if you owned the policy or TRUST , as your ability during lifetim e to had any "incidents of ownership.

5 " This change your will or TRUST would be result is true for term INSURANCE , cash value in your ability to change the beneficial INSURANCE , and even INSURANCE provided enjoyment of the policy proceeds, thus by your em ployer. The Estate Tax rate is bringing the policy back into your 35% once the estate exceeds $5,000,000. taxable estate. The IRREVOCABLE life INSURANCE TRUST can keep life INSURANCE proceeds from being IT'S A GIFT : Your contributions to the taxed in your (or your spouse's) estate. ILIT represent gifts which you cannot get back. The gifts are usually used to pay "Incidents of O wnership" w hich w ill the premiums on one or more policies cause life INSURANCE death proceeds to be insuring your life and which are owned taxed as part of in the insured's taxable by the TRUST .

6 Estate include not just policy ownership, Because you cannot reclaim the policies, but also the right to borrow the cash or receive any benefit from the TRUST , it value, the right to change beneficiaries, would be inappropriate to have the TRUST and the right to change how the proceeds own policies whose cash values you had are ultim ately d istributed to the planned to use for retirement income. beneficiaries. THE $13,000 ANNUAL GIFT TAX. THE ILIT : An IRREVOCABLE L ife EXCLUSION: You can gift up to INSURANCE TRUST (or IL IT) is created to $13,000 per year per donee (2011). o w n one or more policies insuring your without any gift tax im plications. This life . The ILIT is IRREVOCABLE , meaning exclusion is only available to gifts of a you cannot change the terms once it has present interest, and gifts in TRUST been signed, although som e flex ibility generally do not qualify.

7 Can be w ritten into the document. For instance, you can allow others, such 2. To avoid this lim itation, your IL IT UPON DE AT H: The trustee receives the should provide that each lifetim e death benefit upon your death. These beneficiary (who must also be a proceeds can be distributed to your beneficiary or contingent beneficiary at family, held in TRUST , or used to purchase your death) has the right to w ithdraw his assets from your estate o r from your or her proportionate share of the revocable living TRUST . This last option contribution for a limited p eriod of time would be important if your estate had after each contrib ution is made. insufficient liquid assets to pay estate taxes. Usually the TRUST agreement provides that, after a contribution is made, each LIQUIDITY: The tax on your estate is beneficiary will be notified of their right due nin e m onths after the date of death.

8 Of w ithdraw al. For instance, on a ten million dollar estate, the estate taxes will be over $ After the expiration of the withdrawal million dollars. period (usually 30 days), the trustee can use the contribution to pay the premium Those with large estates often do not on a life INSURANCE policy. If the have that much cash or other assets beneficiaries sign a waiver of their which could be easily converted to cash withdrawal rights immediately after the in that time frame. The need to pay estate contribution and notification, then the taxes has caused m any a farm , fam ily trustee can pay the INSURANCE premiums business, or major real estate holding to immediately. be sold at discounted prices to pay the estate tax. IT W OR KS IF: The IRS has approved the ILIT concept when all the technical life INSURANCE can provide the m oney requirements are met, but the IR S is needed to pay the estate tax, and by notorious for challenging ILIT when having the policy purchased and held in these requirements are not met.

9 Even the an ILIT, the proceeds can be used to order in which the documents are signed provide the needed liquidity for your on the same day can be critical. estate and yet not be subject to estate tax on your death. W ith half of your life INSURANCE proceeds at stake, it is not worth taking sho rtcuts M arried couples may w ish to consid er or having a novice prepare your using a "second to die" policy which docum ents. pays the death benefit only after both spouses are deceased. That is usually the EXISTING INSURA NCE POLICIES: exact time, of course, that the proceeds Existing policies can be contributed to are needed to pay the estate taxes. your ILIT, but the death proceeds will be Because no death benefit is paid on the drawn back into your taxable estate if first death, the premium is usually much you die w ithin three years of the lower that purchasing a policy which completed gift.

10 If you are insurable, it is insures just one life . A special type of som etim es advisable to obtain a new ILIT can be drafted to hold such a policy. policy. DIRECT OW NER SHIP: O ften clients Also, the transfer of an existing policy try to accom plish similar results to the can trigger a taxable event should policy ILIT by having, say, their tw o children loans exceed the total premiums paid. ow n the policy equally. 3. M any problems can arise under such an SUMMARY: The ILIT is a IRS- arrangem ent. A child can die; the policy approved means of rem oving your life can be attached and liquidated by a INSURANCE proceeds from your taxable child's creditors; the policy could be estate, and yet still have the proceeds considered as the child's property in the available to provide for your spouse and event of a divorce; one child may refuse children according to your desires.