ILIT funding: Do I transfer my existing life insurance?

Submitted by Anonymous (not verified) on Wed, 01/20/2010 - 09:15

I had consulted my life insurance agent regarding establishing an ILIT, a few days back. He's explained and suggested that I'd need to buy a new life insurance policy. Now, I'd like to know if I could transfer the policy that I already have to my ILIT.

Posted: 20 Jan 2010 03:29 Post Subject:

Yes, but there are few caveats. First, any cash value of the policy will be considered a gift to the ILIT; you don't really want to go beyond the gift tax exclusion amount, which currently is $13,000. Keep in mind you also need "room" to gift the premium to the ILIT for payment.

The agent's suggestion to buy a new policy isn't without merit though. Assuming you currently own the policy you are placing inside the ILIT, you'll have a 3 year period before the IRS will consider you being a non owner and allowing the benefit paid if you die to be excludable from your gross estate. If on the other hand, you gift premium dollars to the ILIT and have the trustee establish a new policy on your life, you will never have had "ownership" of the policy and will not have to satisfy any three year look back.

If you'd like, elaborate more on why you are asking question about establishing an ILIT, and we'd be happy to give you additional guidance.

Posted: 20 Jan 2010 04:18 Post Subject:

I agree with BNTRS. Some more information would be helpful though. However, I will add that the gift tax exclusion amount is $13,000 per beneficiary within the trust, and both husband and wife can gift the amount. So if you have one beneficiary, you could gift up to $26,000 without eating into your lifetime maximum gift tax exclusion (which is $1 million). If you have three beneficiaries, you could gift up to $78,000 per year, etc. If you are not married or the spouse is deceased, it would be $13k times the number of beneficiaries. The answer to the following questions would help:

1. How long is your current policy guaranteed for?

2. How long do you want to keep the coverage?

3. Does your current policy have any cash value?

3. Is this a second-to-die policy for estate planning purposes? If not, what is the reason for putting the policy into the ILIT?

Posted: 20 Jan 2010 05:50 Post Subject:

It might make sense, but we don't have enough information.

BNTRS mentioned one of the problems if death occurs too soon. However, this problem can usually be solved simply by buying some "extra" insurance (cheap term) for 3 years.

Posted: 21 Jan 2010 09:56 Post Subject:

hi dgoldenz,

What's this second-to-die policy?

If you are not married or the spouse is deceased, it would be $13k times the number of beneficiaries.

Is it the same across all states within the U.S.?

Posted: 21 Jan 2010 03:15 Post Subject:

Second to die policy is a policy that pays a death benefit upon the second spouse's death, but is held jointly by both spouses. It's used primarily for estate planning purposes where there will be an estate tax issue and the plan is to essentially transfer all assets to the surviving spouse and then probate the estate upon the second spouse's death--this is when an estate tax would be due.

It's quite cheaper than both spouses having ILITs and funding them to buy life insurance on both their lives.

However, there is a strategy for estate tax purposes that would suggest probating both estates and splitting the assets between the spouses. This would require less life insurance since estate taxes would be less. It would also allow both spouses to use their estate tax exemption instead of just one. It's a tad more complicated. There are insurance products out there that will allow an insured to named another insured and give them the right to purchase have insurance purchased on their own life upon the death of the original insured.

So the chain of events that would take place under the second strategy (without using second to die insurance) would be: spouse 1 dies, death benefit paid, part of death benefit goes towards buying new life policy on spouse 2's life, spouse 1's 50% of the assets are sent to estate and remaining life insurance proceeds can be lent to the estate to help pay for remaining estate tax liability after spouse 1's exemption has been used up. Then when spouse 2 dies, there is a funded ILIT ready to take care of remaining estate tax liability after spouse 2's exemption has been used up. Again the strategy seeks to make less of an estate tax liability and as a result a lower insurance need/cost. It's an interesting idea, but I've never personally seen it work out all that well.

The $13k gift limit per beneficiary is a federal law so yes, applicable to all 50 states. You can give anyone you want a $13k gift per year without dipping into your lifetime gift credits.

Posted: 21 Jan 2010 04:18 Post Subject:

BNTRS, it does not make sense to use a 2nd to die policy the way that you are describing it for estate planning purposes. Let's say that it is a $5,000,000 policy and the combined federal and state rate is 50%. You have just increased their estate by $5,000,000 at the second death and increased the estate tax by $2,500,000.

The way that it is typically done is that an ILIT will be the owner and beneficiary of the insurance policy. This way, the $5,000,000 will be out of the estate and be income and estate tax free.

I can't see any advantage to a second to die policy being jointly owned instead of being owned by the ILIT.

Posted: 21 Jan 2010 09:02 Post Subject:

Yup poor choice of words, jointly held = jointly insured but owned by ILIT.

So to be clear about the process. Gift premium dollars to ILIT, have trustee purchase Second-to-Die policy on spouses. First spouse dies, not much happens (some have riders that change premiums or waive premiums for a little while, or even pay up policies), second spouse dies death benefit is paid into ILIT where it avoids estate taxability. Beneficiaries of ILIT can then use ILIT proceeds to lend money to the estate to pay estate taxes.

Posted: 22 Jan 2010 09:02 Post Subject:

He's explained and suggested that I'd need to buy a new life insurance policy.

Once you'd get a new life insurance, then it's original application is supposed to get signed by your ILIT trustee. If you haven't established your ILIT while applying for the new policy, then you might need to do it soon and also make sure that the ILIT trustee is turned into your new policy owner before it gets issued. Also you'd need to ensure that the ILIT gets mentioned as the "beneficiary" in your application.

Posted: 22 Jan 2010 09:58 Post Subject:

If there's no ILIT, there's no point in applying. Too many possible problems.

Posted: 22 Jan 2010 10:18 Post Subject:

If there's no ILIT, there's no point in applying. Too many possible problems

I disagree with this. The reason is that an ILIT isn't cheap to establish and it is possible for the person to get turned down for insurance or the rates to be too high. Here's a different way to handle it. Get agreement from everyone that the insurance will go into the ILIT. Have the individual apply for coverage. When it's approved, don't accept the policy. Set up the ILIT. Reapply for coverage with the ILIT as the owner and beneficiary.

If the lawyer or something is going to hold up the insurance purchase, don't let this happen. Have the client buy more coverage than needed. They can personally own it. The extra can be a term rider. Once the lawyer stops dragging his feet, the existing policy can be put into the ILIT. If death occurs too soon, it will be part of the estate, but because of the extra coverage, the client's family will be fine.

I've seen too many cases that got blown up waiting for an ILIT to get established.

Posted: 23 Jan 2010 04:34 Post Subject:

Yes, that makes sense, my post was kind of a rash reaction to the suggestion that if you have already applied and don't have an ILIT you should try to get the ILIT quick and change everything over before issue.

Posted: 23 Jan 2010 04:37 Post Subject:

Underwriting for a second-to-die case usually takes about 2 months. There is no way it should take 2 months for a lawyer to set up an ILIT. If the application is completed stating the beneficiary is to be placed in trust and changed to the ILIT upon delivery, there shouldn't be any issues.

Posted: 23 Jan 2010 09:04 Post Subject:

It shouldn't take 2 months for the lawyer. The problem with taking care of the ILIT first is that if the insurance gets declined and/or is too expensive, the client is going to have to still pay for a useless ILIT. Also, although it could always take a couple of months to get a policy approved, if everything is pretty clean, it could also get done in a week or two.

The problem with just changing the beneficiary to the trust is that the trust won't be the original owner. This would make it part of the taxable estate if death occurs too soon. It is best for the trust to be the owner from the getgo. You just don't want the setting up of the trust to delay the process.

Posted: 24 Jan 2010 03:00 Post Subject:

The ILIT is not subject to the 3-year contemplation of death if the application states the owner will be the ILIT without specifically naming it (since it doesn't exist yet, obviously). As long as the owner is changed to the specifically named ILIT before the policy is issued and signed for, it should be fine. Most people looking for second-to-die for estate planning policies will set up an ILIT despite the cost because they need it even if the insurance comes back more expensive than intended. Very few people will decline to take the coverage, most will just take a lower amount to fit their budget if the underwriting is worse than projected. You would have to have two VERY unhealthy people to have both be declined....even people who would be declined on their own can still get coverage on second-to-die depending on the health of the other person.

Posted: 24 Jan 2010 03:33 Post Subject:

Once you'd get a new life insurance, then it's original application is supposed to get signed by your ILIT trustee.

I don't think it can happen this way. All the required signatures happen before underwriting and policy issue, not afterwards.

Posted: 24 Jan 2010 02:53 Post Subject:

dgoldenz, I don't understand what you are saying. The application must be signed by the owner. If the ILIT is going to be the owner, one can't just state that the ILIT will be the owner.

Lots of time if the underwriting comes back worse than expected, the ILIT may not make sense. For instance, let's assume that we're using a Guaranteed UL policy. We expect it to be issued Standard + and as such, it works out to be a 6% return if the insured(s) live another 20 years. The policy may come back Table B and at 20 years, it comes out to a 4% return. It may then make more sense to gift the money, but invest it instead of buying life insurance.

As an aside, in most circumstances, I'd rather see the insured's get two separate policies for half the amount than one 2nd to die policy. If there is a decent amount of time between deaths, this can lead to there being far more money.

Posted: 31 Jan 2010 08:02 Post Subject:

Sorry it took me so long to respond to this, haven't been on here in a bit.....the application is completed by the insured with the beneficiary as "to be placed in trust", and then after the ILIT has been set up and the policy is ready to issue, a new application citing the ILIT as the owner and beneficiary is completed and sent in. This allows the underwriting to be completed while the ILIT is set up and avoids the problem of the 3-year contemplation of death rule.

Posted: 01 Feb 2010 09:41 Post Subject:

No problem.

Posted: 21 Jun 2010 03:44 Post Subject: ILIT Management

Also make sure that the ILIT Trustee has all of the tools needed to lawfully carry out their duties to the grantor, the beneficiaries, the law itself. Many Trustees struggle to take care of the demanding job that faces them, and are barely equipped to deal with the personal liability they'd face if things really go awry.

**Edited by dgoldenz for spam**

Posted: 22 Jun 2010 02:20 Post Subject:

And I'm sure if people are doubting their trustee's ability to do his or her job, the trust company you work for would be more than happy to step in for a small fee.

Posted: 22 Jun 2010 07:41 Post Subject:

Choosing a third-party trustee can be a wise decision. They should have the ability to approach specific situations impartially and without all the drama that could be imposed on a person with closer ties to the trust or its beneficiaries.

One problem that used to plague some trusts which were initially established through a local "community bank", where the grantor and the trustee had a personal relationship, was the acquisition of the smaller banks by their greedy national competitors, and the loss of personal service that resulted. It often made it impossible for the beneficiaries to change trustees before they did actual harm to the value of trust assets.

The most important thing about life insurance trusts is the timing and method of placing the insurance in the trust. As several have pointed out, the best plan is to make the trust the owner at the time of application so there is no doubt about the intent concerning ownership. Outside that, the three year lookback rule could be the inspiration for a real-life "Weekend at Bernie's" event.

Kind of like the two guys who wheeled their dead friend in an office chair to a Social Security Office in NYC a couple of years ago in a fraudulent attempt to collect his check. When the SS Rep asked where the recipient was, they said, "Oh he's outside, 'cause he's not feeling too well." Unfortunately, by that time a small crowd had gathered around the dead guy because he was about to fall out of the chair, with his pants down around his thighs (the two knuckleheads couldn't figure out how to dress the corpse properly), and it was apparent that he was dead.

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