Aaron Charles Gregg

Consider a Trust for Upcoming Estate Tax Exemption Change

“Properly drawn up trusts can provide both control (particularly in terms of picking the right trustee) andtax savings, aswell as creditor protection for beneficiaries, advisors say.”As the expirationofthe Tax Cuts and Jobs Act provisionsaboutfederal estate taxes comes closer,peoplewho have enjoyedultra-high exemptions in recent years may find themselves paying estatetaxes if theydon’t plan ahead. A recentarticleinFinancial Advisor,“Looming Cut in Estate Tax Exemption HasAdvisors Looking ToTrusts,”provides a look intohowtrusts,created with an estate planning attorney toalign with the overall estate plan,can mitigate estate tax changes and more.A revocable living trust is notpart of the public record, so assets in the trust aren’t available to creditorsor litigants after your last will and testament goes through probate. A revocable trust,created andfundedduring the grantor’s lifetime,allows the grantor full access and control over the trust and assets.Uponthe grantor's death,the trust's assetsmay passdirectly to the beneficiaries without going throughprobate.Another kind of trust is theQualifiedTerminable Interest Property Trust, or QTIP. This kind of trust canown different assets; aspouseis thebeneficiary. The assets in the trust can include stocks, bonds, realestate, business interests,or just plain cash.Thebeneficiarymustget allthe income thrown off by thetrust, and any remaining assets mustgo to other beneficiaries.Then there’s the“ILIT”—an irrevocablelife insurance trust—allowing individualsto remove policyproceeds from the estate.With the guidance of an estate planning attorney, the policy owned by thetrust can generate streams of tax-free income for the surviving spouse.For younger people, a GRAT—grantor-retainedannuity trust—returns some or all of the value in thetrust plus interest to the person creating the trustand transfers appreciation outside of the estate. Thisworks best when the GRAT growsquickly in the firstfew years. At the end of the GRAT,theremainingassets are distributed to an irrevocable trust for beneficiaries.These are just a few waysthattrusts can be usedto minimize estate taxes strategically. Talk with yourestate planning attorney to ensurethatyou are ready if and when the tax laws change. Bear in mindthatthe estate planning and financial community are already preparing for these changes,whichtake time.Waitinguntil the last minute could be an expensive mistake.Reference:Financial Advisor(May 28, 2024)“Looming Cut in Estate Tax Exemption Has Advisors LookingToTrusts

How Does an Irrevocable Life Insurance Trust Work?

“Life insurance is often a cornerstone of a comprehensive estate plan, particularly when an estate consists of largely illiquid assets.”

Irrevocable Life Insurance Trusts (ILITs) are a common planning tool. However, buying the policy at the wrong time, leaving out Crummey withdrawal rights and ignoring administrative costs are commonly made mistakes. Being aware of these snares is important to make the ILIT effective, says a recent article titled “Irrevocable Life Insurance Trusts in Estate Planning: Common Pitfalls” from Think Advisor.

Purchasing a new policy outside of the ILIT is a commonly made error. If you purchase a new life insurance policy and then transfer it to the ILIT, the death benefit will be included in your estate for estate tax purposes if you die within three years of the transfer. This undoes any estate tax advantages of the insurance policy and the trust.

IRS Section 2035 causes estate tax inclusion for anyone who transfers or otherwise gives up power over a life insurance policy within three years of death. However, there are ways to address this. If you first establish and fund the ILIT first, so the ILIT is the entity purchasing the policy directly, the death benefit is excluded from your estate regardless of how long you live after the purchase date.

Another error concerns the “Crummy Protocol.” Unless or until the premiums on a life insurance policy are fully paid or are self-sustaining through a draw on the cash surrender value, the insured must make gifts to the ILIT to pay for the premiums. People often like to use their annual gift tax exclusion to make contributions. However, to qualify the gifts for the annual gift tax exclusion, the beneficiaries of the ILIT must have the right to withdraw certain amounts transferred into the ILIT.

Failing to include the required withdrawal rights may eliminate the ability to offset gifts by the annual exclusion right. Even if the ILIT includes Crummey withdrawal rights, you won’t be able to take advantage of the annual gift tax exclusion if the beneficiaries are not informed of their withdrawal rights each time an eligible contribution is made to the ILIT.

Your estate planning attorney will advise you as to how this occurs from a procedural perspective. You’ll want them to review it before it is signed to confirm it includes Crummey withdrawal rights and to help you establish procedures for providing the requisite notice and waiting the required period each time a gift is made.

Lastly, ILITs often have limited assets since they may only be funded with the insurance policy and the amount needed to pay the premiums. Therefore, if the ILIT has any administrative expenses, like accounting, legal or trustee funds, there may be insufficient assets in the ILIT to pay them.

If you pay the expenses directly, they will be considered as making a gift for gift tax purposes, because you will be deemed to have first transferred to the ILIT any amounts paid on its behalf. Avoid this issue by funding your ILIT with the necessary money to pay premiums and administrative costs. If the class of beneficiaries holding Crummey withdrawal rights is broad enough, this may be done solely through annual exclusion gifts.

Reference: Think Advisor (Sep. 29, 2022) “Irrevocable Life Insurance Trusts in Estate Planning: Common Pitfalls”

What is the Purpose of an ILIT?

“Life insurance is a sophisticated financial product, with as many variations and permutations as there are creative insurance companies (there are many) and creative insurance planners (there are even more).”

Life insurance falls into two categories: life insurance and death insurance. Life insurance is used to take advantage of the tax-free returns that qualifying insurance products enjoy under federal income tax laws. There is a death component. However, the main purpose is to serve as a tax-deferred investment vehicle. Death insurance is used to provide financial security for loved ones after the owner passes, with little or no regard for tax and investment benefits.

Using both types of life insurance in estate planning can be a complicated process, but the resulting financial security is well worth the effort, as reported in a recent article “Keeping an Eye on ILITs” from Financial Advisor.

The Irrevocable Life Insurance Trust is a somewhat complex trust structured under state trust law and tax strategies under federal income tax laws. ILITs have been tested in court cases, audits and private letter rulings, so an estate planning attorney can create an ILIT knowing it will serve its intended purpose.

Life insurance in an ILIT is owned outside of the estate and enhances the after-estate tax wealth for the surviving spouse and heirs. Because the trust is irrevocable, the transfer of ownership is permanent.

The annual insurance premium is typically paid by the insured to the ILIT, subject to “Crummey” withdrawal powers, named after a famous case, which gives named people the power to withdraw all or a portion of the contributed premium amounts within specified periods. The time frame depends on the trust—usually it’s 30 or 60 days, but sometimes it’s annually.

There are many nuances and details.  The ILIT lets an insured buy life insurance “outside of their estate” for estate tax purposes, lets the person treat insurance premiums as non-taxable gifts under the annual exclusion provisions and provides safety and security to the beneficiaries.

The ILIT is often used as part of a buy-sell agreement for privately held family businesses to make it possible for the business itself or business partners to buy out the equity of a deceased partner. The payment obligations may be funded by the proceeds from life insurance. In some cases, each partner buys a traditional insurance policy in an ILIT. The estate planning attorney working on a succession plan can provide advice on the most effective way to use the ILIT.

Another use for the ILIT is for wealthy families with illiquid assets, like an art collection or a large real estate portfolio. An ILIT holding a life insurance policy with a death benefit lets the beneficiaries use the proceeds to pay estate tax liabilities, without dipping into their own or the estate’s assets. The investment returns of the ILIT increase the policy owner’s wealth substantially, without increasing their taxable estate.

Reference: Financial Advisor (December 1, 2021) “Keeping an Eye on ILITs”

What Is Purpose of an Irrevocable Life Insurance Trust?

“Death and taxes may be certainties of life, but how much tax your family pays upon your death is still within your control to a certain degree.”

Irrevocable Life Insurance Trusts, or “ILITs” are life insurance policies owned by irrevocable trusts used to manage taxes on estates. There are complexities to using an ILIT, but the benefits for some people could be big, according to the article “What Advisors Should Know About Irrevocable Life Insurance Trusts” from U.S. News & World Report.

What is the goal of an ILIT? The goal of an Irrevocable Life Insurance Trust is to own a life insurance policy, so the proceeds of the policy are left to heirs, who avoid estate tax. It’s a type of living trust but one that cannot be dissolved or revoked, unless the trust does not pay premiums and the insurance policy owned by the trust lapses.

The federal estate tax exemption is currently $11.58 million for individuals, and $23.16 for married couples. Most people don’t need to worry about paying federal estate taxes now, but this historically high level will not be around forever. The current law ends in 2025, cutting the exemption by half. If Congress needs to raise revenue before then, change could come sooner.

Who needs an ILIT?

The main advantage of an ILIT is providing immediate cash, tax free, to beneficiaries. The value of the ILIT is out of the estate and not subject to taxable estate calculations. The life insurance policy ownership is transferred from the insured to the trust. The insured does not own or control the insurance policy, but this is a small price to pay for the benefits enjoyed by heirs.

The grantor is the insured person, and the policy is purchased with the ILIT as the owner and the beneficiary. The insured cannot be the trustee of the trust. In most cases, the trustee is a family member, and the insurance premiums are paid through annual gifting from the insured to the trust. These are the details that should be explained by an estate planning attorney to maintain the trust’s legitimacy.

If all goes as planned, when the insured dies, the ILIT distributes the life insurance proceeds tax-free to beneficiaries.

How does an ILIT work?

Let’s say that you have assets worth $15 million. You buy a life insurance policy that will pay $5 million to your children. When you die, your taxable estate would be $20 million, which in 2020 would incur about $3.3 million in federal estate taxes. However, if you used an ILIT and the ILIT owned the $5 million policy instead of you, your taxable estate would be $15 million. Your federal estate tax in 2020 would be about $1.3 million. The estate would save $2 million simply by having the ILIT own the $5 million life insurance policy.

What if the estate tax exemption goes down before you die?

If the estate tax exemption goes down and you have already funded the ILIT, it remains safe from estate taxes. Here is another reason to consider an ILIT—as long as the funds remain in the trust, they are safe from beneficiary’s creditors.

Are there any downsides to an ILIT?

ILITs are not do-it-yourself trusts. They are complex and need to be structured so that the annual contributions used to pay the insurance premiums qualify for the $15,000 gift tax exclusion. To do this, an estate planning attorney will often include a “Crummy” power, which allows the insured to pay the trust for the premium, without reducing their lifetime gift tax exemption amount. However, it also means that beneficiaries need to be well-educated about the ILIT, so they don’t make any errors that undo the trust.

When a contribution is made, Crummey letters are sent to the beneficiaries, letting them know that a gift was made to the trust and they have the right to withdraw the money. However, if they withdraw the money, the insurance policy could collapse.

You’ll need to be committed to keeping this policy for the long run. You’ll need to be able to fund it appropriately.

There is also a three year look back for existing insurance policies that are moved into the ILIT, so the grantor must be alive for three years after the policy is given to the ILIT for it to remain outside of the estate. This does not apply when a new policy is established in the ILIT and does not apply if the ILIT buys the policy from the grantor.

Reference: U.S. News & World Report (Oct. 29, 2020) “What Advisors Should Know About Irrevocable Life Insurance Trusts”

What Do I Need to Know About an Irrevocable Life Insurance Trust?

“An irrevocable life insurance trust (ILIT) is a structure that cannot in any way be rescinded, amended, or modified, after its initial creation.”
An irrevocable life insurance trust (ILIT) is a trust that can’t be rescinded, amended, or modified after it’s created. ILITs are made with a life insurance policy as the asset owned by the trust. Once the grantor places property or life insurance death benefits into the trust, she can’t alter the terms of the trust or reclaim any of the properties held by it.
As an alternative to designating an individual beneficiary, ILITs offer several legal and financial advantages to heirs. This includes favorable tax treatment, asset protection, and the assurance that the benefits will be used in a manner concurrent with the benefactor's wishes.
Investopedia’s recent article, “When Is It a Good Idea to Use ILIT Trust?” says that there are several advantages to ILITs, including state tax considerations, the protection of fiscally-careless beneficiaries from squandering their payouts and the prevention of courts and creditors from accessing the assets.
An ILIT is often used to set aside assets for certain purposes, like paying estate taxes, because these assets themselves aren’t taxable. To do this, the selected assets must be moved into the life insurance trust at least three years before they’re used. If you use a qualified estate planning attorney to create this, the death benefits paid to the ILIT won’t be included in the gross estate of the insured. This is different than when life insurance death benefits are paid to an individual, because the proceeds are included in the taxable estate of the decedent.
The ILIT also has asset protection for the beneficiaries, if they are involved in a lawsuit. That’s because ILITs aren’t considered to be owned by the beneficiaries. This makes it hard for courts to connect the assets to the beneficiary, making them nearly impossible for creditors to access.
There are some drawbacks to using an ILIT, so carefully consider the pros and cons of creating one. Changes to an ILIT can only be made by the beneficiaries. As a result, the benefactor loses control of the assets prior to death. ILIT assets also are not taxed as part of the estate, but they are taxed as part of the beneficiaries' estates, leaving a bigger tax burden to their descendants.
Preparing an ILIT is a sophisticated matter, with strict guidelines that must be followed to ensure that it conforms with IRS guidelines. Talk with an experienced estate planning attorney to be sure that it is prepared properly, and that it aligns with your overall estate plan.
Reference: Investopedia (August 5, 2019) “When Is It a Good Idea to Use ILIT Trust?”

Do I Have to Pay Taxes on My Inheritance?

“An inheritance is not subject to income taxes.”
For all practical purposes, the U.S. government doesn’t have an inheritance tax. The inheritances of cash or property aren’t taxed as income. As of 2019, the estate tax is only imposed on estates above $11.4 million for singles, or twice that for couples.
Investopedia’s recent article asks “Are Estate Distributions Taxable?” The article explains that the only exception is for income taxes due on withdrawals from retirement accounts that are ordinarily subject to taxes, like traditional IRA accounts.
However, some states do tax inheritances, and to date, those states include Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. None of those states applies the tax to the spouse or children of the deceased. When imposed, the taxes range from about 5% to about 15% of the inheritance.
If an estate executor doesn’t pay income tax before he or she distributes the inheritance, the IRS may impose limited beneficiary taxes on those who inherit.
Right now, the federal estate tax applies only to inheritances above $11.4 million per individual. Estates, just like individuals, are required to file income tax forms. They may also owe taxes in the form of interest payments on accounts.
The estate can pay the taxes due or distribute the taxable income to the heirs. In certain cases, this actually saves the beneficiary money because the entire estate may be in a higher tax bracket than the individual who’s getting just a portion of the inheritance.
An exemption to the estate tax for inheritances up to $5 million was instituted about nine years ago in 2010 and 2011 (but there were special rules for decedents dying in 2010). This exemption has been reaffirmed, and the limits have been raised in subsequent laws passed by Congress. The current rules exempts from estate taxes the first $11.4 million inherited by an individual, and twice that amount if the inheritance is distributed to a couple.
It’s believed that approximately 2,000 Americans a year are liable for the inheritance tax under that tax exemption law. These individuals usually work with estate planning attorneys and accountants who are skilled at finding strategies to avoid or minimize the estate tax they owe. One way of avoiding any estate tax, is to give away some of the estate in advance to family members. Your attorney may also discuss the use of an irrevocable life insurance trust.
Reference: Investopedia (August 4, 2019) “Are Estate Distributions Taxable?”

Should I Use an Irrevocable Life Insurance Trust?

“An irrevocable life insurance trust (ILIT) can provide peace of mind, as you start your estate planning process. If you have a sizable estate or young beneficiaries, an ILIT can provide control over a life insurance policy that a last will and testament may not.”

The word “irrevocable” in an irrevocable life insurance trust (ILIT) means that its creator (also called the “grantor”) can’t change it once it’s set up. This type of trust has its benefits but there are some things to consider before setting it in stone. Revocable trusts are more commonly used, because they have greater flexibility for the trust creator to make changes to the trust terms.

KAKE.com’s recent article, “How an Irrevocable Life Insurance Trust (ILIT) Works,” explains that a revocable trust lets the grantor change or even end the trust. An irrevocable trust permits no modifications from the trust creator, once it’s been drafted. The only ones allowed to make and approve changes are the beneficiaries. However, these trusts have some benefits despite their inflexibility.

With an irrevocable trust, death benefits will not be part of your gross estate, so they aren’t subject to state and federal estate taxes. However, while your estate is exempt from estate taxes, they may be subject to taxes in your beneficiaries’ estate, which can shift your tax burden onto them.

An irrevocable trust allows restrictions to be put in place for minors who may not be responsible or equipped to handle large amounts of money. You can set up terms, so beneficiaries have to attain a certain age to gain assets or accounts.

An irrevocable trust can also protect you and your family from creditors.

The IRS says that life insurance payouts are usually not included in your gross assets, but there are exceptions. If you’ve earned interest on a life insurance payout, any interest you received is taxable. In addition, if a life insurance policy was transferred to you by another individual for money, only the sum you paid is excluded from taxes.

There are some drawbacks to an ILIT. Some of the tax benefits of an ILIT only work in if you live three or more years after transferring your own life insurance policy to the trust. Otherwise, the IRS will include life insurance proceeds in your estate for estate tax purposes. The ILIT can buy the policy and avoid that rule, but you’ll have to fund the trust to pay premiums.

Giving the trust money for that policy may also make you subject to gift taxes. However, if you send beneficiaries a letter after each transfer telling them that they don’t have immediate access to the money, gift taxes won’t apply.

The biggest downside to an ILIT is that you can’t change it once it’s established. You give up control of assets and can’t dissolve the trust, unless you simply stop making payment for premiums. Although the trust rids you of certain taxes, your beneficiaries may take on a big tax burden, once they get the assets in your estate.

An irrevocable trust can be complex, even when life insurance isn’t involved. You should work with an experienced estate planning attorney to see if this an option for you.

Reference: KAKE.com (July 19, 2019) “How an Irrevocable Life Insurance Trust (ILIT) Works”

What are the Benefits of an Irrevocable Life Insurance Trust (ILIT)?

“The reality is that life insurance is treated as an asset in your estate. If the payout pushes your estate past federal or state estate tax exclusion limits, you could be facing a hefty estate tax bill. There is something you can do, though.”

Many people just assume that all insurance is tax-free. However, that’s only partly true. Life insurance is income tax-free. Therefore, the recipients of a decedent’s life insurance policy don’t have to pay income tax on that amount.

However, Kiplinger’s recent article, “Myth: Life Insurance is NOT Taxable,” explains that if it’s large enough, the decedent’s estate—along with any life insurance proceeds—could be subject to federal and/or state estate taxes.

For instance, if you have a $1 million life insurance policy, the IRS will deem that policy to be an asset. At your death, the IRS sees it as a million-dollar asset you just transferred to your beneficiaries, and taxes it accordingly. That estate tax is usually due upon death, and it can be significant. If you’re wealthy enough to be worried about this, you can avoid having your life insurance proceeds included in your estate and subject to the estate tax, by creating an irrevocable life insurance trust (ILIT). You name that trust the owner of your life insurance. That way, that particular asset will be removed from your estate (if you have had no control over the policy for at least three years). When you die, the proceeds from your life insurance will pass on to your heir’s income tax and estate tax-free.

You may be a candidate for an ILIT, if your estate is in excess of the federal “application exclusion amount” ($11.18 million for single individuals and $22.36 million for couples under the Tax Cuts and Jobs Act of 2017.) The Act sunsets on Dec. 31, 2025. At that point, unless the law is made permanent, the amount will go back to the old $5 million exemption, indexed for inflation.

An ILIT could save your family up to 40% in federal estate taxes. That’s a benefit worth the expense and complexity in setting it up. However, it is important to note that 12 states and DC have their own estate taxes, and their exclusion amounts may be lower than the federal limits.

In addition, an ILIT can help you can avoid tax on both spouses’ estates. Life insurance proceeds can be held in a trust for the benefit of the surviving spouse during her lifetime. When she dies, the proceeds will not be included as part of her estate either. They will pass tax-free to her children and then to her grandchildren, as an ILIT in a multigenerational trust.

It is important to use caution because the IRS scrutinizes ILITs carefully. In order to be certain that your ILIT passes IRS muster, you must:

• Transfer polices you own to the ILIT, by completing an “absolute assignment” or “change of ownership” form;
• Relinquish all ownership rights to the trust. You must keep insurance proceeds out of your estate, by doing the following:

o   Giving up all ownership rights to the policy, such as the right to change beneficiaries, borrowing from cash values, and making premium payments;

o   Sign an annual cash partition agreement to create separate funds from which premiums are paid; and

o   Maintain a change of ownership in an existing policy for at least three years before the insured's death. (You must survive for at least three years after transferring your policy to the trust, or the proceeds will be taxed in your estate like you retained ownership of the policy).

Work with an experienced estate planning attorney to set this trust up correctly.

Your family won’t pay income tax on any life insurance proceeds they receive, but if the estate is big enough, they’ll pay estate taxes on the policy, unless you set up an ILIT at least three years before your death.

Reference: Kiplinger (August 28, 2018) “Myth: Life Insurance is NOT Taxable”