Irrevocable Life Insurance Trust ("ILIT")

Life Insurance plays a part in most estate plans. Make sure you have sufficient
coverage on your life for family members to maintain their current lifestyle after you
are gone. For larger estates that may be subject to tax even when family trusts are
used, life insurance can provide the funds needed to pay estate taxes without
liquidating estate assets.

Description

The irrevocable life insurance trust ("ILIT") is a popular, but complex, estate planning
technique used to minimize transfer taxes--estate, gift, and generation skipping tax --
while providing liquidity, replenishing wealth lost to taxes, and permitting the
management and control of policy proceeds. The technique utilizes an irrevocable
trust as owner and beneficiary of life insurance policies to avoid subjecting the policy
proceeds to tax in your estate. Because the ILIT can avoid transfer taxes while
permitting use of the policy proceeds by your estate, it is a very useful estate planning
tool.

Background

The beneficiary of a life insurance policy generally will not pay income tax on receipt
of the policy proceeds. But if the insured possesses any "incidents of ownership" in
the policy the value of the policy proceeds will be includable in the insured’s estate
for estate tax purposes. This can be a very expensive consequence. If the insured’s net
worth, including policy proceeds, exceeds $1,000,000, as much as 55 cents from
every dollar of policy proceeds could go to pay estate taxes. If the beneficiary of the
policy is someone other than the insured’s estate, the proceeds may not be available as
a source from which the taxes can be paid. Generally, "incidents of ownership" in a
life insurance policy include (1) the power to change the beneficiary, (2) the power to
borrow against the policy, and (3) the power to transfer the policy. If you possess any
of these powers over life insurance policies, the policy proceeds will be includable in
your estate.

On the other hand, if you do not possess any of these powers, no amount of the policy
proceeds will be includable in your estate and the policy can pass free of both income
and estate tax. You could transfer ownership of the policy to another individual to
avoid inclusion of the policy proceeds in your estate, but this gives rise to at least two
problems: (1) when the new "owner" dies, the policy proceeds will be includable in

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his or her estate (so if the new "owner" is your spouse, this accomplishes no tax
savings), and (2) upon the transfer, you give up the ability to control the beneficiary of
the policy proceeds. Alternatively, you could transfer ownership to an ILIT, which
you create, and which is also the beneficiary of the policy. If properly structured, the
policy proceeds should be excludable from your estate yet you can still control,
through the dispositive provisions of the trust, the use of the policy proceeds.

Planning

An ILIT is an irrevocable trust created by you. You designate its trustee and
determine all terms of the trust. After the ILIT is formed, you will either transfer your
existing policy to the trustee, or the trustee will apply for a new policy on your life.
The trustee, as owner of the policy, will name the trust as beneficiary. Upon your
death, the trustee will collect the policy proceeds and dispose of them in accordance
with the terms of the ILIT. Moreover, the proceeds can be used to ease any liquidity
problem in your estate, because the ILIT can purchase assets from or lend money to
your estate. The terms of the trust can be very flexible, and often provide for surviving
spouse and/or your descendants.

• Existing Policies

By transferring an existing policy to an ILIT you should avoid inclusion in your estate
of the policy proceeds if you survive the date of transfer by three years (the "three-
year rule"), and the trust is operated correctly. If you do not survive the date of
transfer by three years, the policy proceeds will be included in your estate under the
current Internal Revenue Code.

• New Policies

If you purchase a new life insurance policy in an ILIT, the "three-year rule" does not
apply and the proceeds should escape taxation in your estate of the ILIT is properly
operated.

• Gift Taxes

Policies which are not "paid up" will require premiums to be paid. Because the ILIT
will be the owner of the policies, the trust will pay the premiums. When you
contribute cash to the ILIT for the ILIT to pay the premiums, that is a gift. Properly
structured, you can contribute up to $11,000 per person (or as much as $22,000 per
person if you are married), per year free of gift taxes. Special steps must be followed
to avoid gift taxes on these transfers. If you contribute existing policies to an ILIT that

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have cash value, that is also a gift to the ILIT at the time of contribution. A gift tax
return may be necessary to report the gift.

• Income Taxes

During your lifetime, any income earned on assets held in the trust will be taxable to
you. Life insurance policies are generally not income-producing assets so the ILIT is
unlikely to incur income tax during your life. After your death, the ILIT will become a
separate taxpayer and report income earned on the insurance proceeds.

Advantages of an ILIT

An ILIT provides an excellent means of achieving (1) favorable transfer tax treatment
of life insurance, (2) continued management of the insurance proceeds for
beneficiaries, (3) a means of disposing of the life insurance proceeds consistent with
your personal wishes, and (4) access to the life insurance proceeds by your estate.
Again, while common, an ILIT is a complex trust that must be properly structured and
operated to achieve the desired tax consequences.

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 Checklist for Paying Premiums for a Life Insurance Policy Held in an
Irrevocable Life Insurance Trust

_____Write a check to the trustee of the trust in an amount sufficient to cover the
premium.

_____The check should be made payable to "[name of the trustee],

trustee."

_____The check should be signed by the insured/settlor who created the

trust. If you created a trust that owns insurance on your life, and your
spouse is a beneficiary of the trust, your spouse should not sign any
checks payable to the trust.

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 _____The check should be delivered to the trustee thirty (30) or more
days before the premium is due.

_____You may need to write the check for a small amount in excess of
the amount of the premium, so that the trustee may maintain a minimum
balance in the trust’s bank account.

_____Give written notice of the gift to each beneficiary who has a right to make
withdrawals with respect to that contribution.

_____This notice should be sent to the beneficiaries before or at the

same time that you send the check to the trustee. We will provide you
with a form to use for giving these notices. If you have questions about
the notices, or want us to prepare the notices, be sure to let us know well
before the premium is due.

_____Each beneficiary should sign a copy of the notice to acknowledge

receipt. If the beneficiary is a minor, the notice can be signed by the
minor’s parent – this should be the parent who is not insured by the life
insurance policy owned by the trust.

_____The trustee should keep the signed notices as part of the trust records.

_____The trustee should deposit the check in the trust’s bank account.

_____After receiving all the disclaimer letters back from the beneficiaries; the trustee
should write a check for the premium and send it to the insurance company. This
check should be sent when the premium is due (after the money to pay the premium
has been in the trust’s bank account for thirty days) and always before the thirty (30)
day "grace period" ends.

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