Irrevocable Life Insurance Trusts, or ILITs, are a wonderful way for clients with complex estates – or difficult heirs – to manage their life insurance policies.
This isn’t our first go-round with ILITs, yet earlier, I neglected to emphasize a common mistake that undermines the strategy, killing it dead. I’m just brave enough to illustrate this pitfall by sharing the most embarrassing thing I’ve ever done as an adult. I was wearing a tie and a nice jacket when I did it, so there’s no cause for blushing.
I’ve mentioned the tale of losing my job in Singapore, how the equity research department shut down as if blown by a breeze. I was at my desk, ten minutes to seven, when the email came in. “That’s funny,” says I, “the morning meeting is cancelled.”
I understood, but couldn’t grasp it. The two senior analysts pulled hidden boxes from under their desks, began loading their stuff. It was a moment, as French war memoirs recount, that the bloodied survivors would never forget. ‘Ah, la vache!’ Goldarn it to heck!
I resolved not to mosey to the neighboring glass tower, though a job was reportedly on offer. Resolution: move someplace cheap and do – nothing! For one year. ‘Nothing’ never occurred. I went to Thailand and set up my freelance shop. It wasn’t as easy as that: first, there was paperwork.
Visa application; passport copies, two; photos, six. Health exam; criminal record. If you’re foreign and want a criminal background check in Singapore, you must ask permission to ask for one, proving why you need it, with documented proof and two pictures. The application was 12 pages long; the ‘please’ process took three weeks; the results, another two.
Of course I wasn’t a criminal. If I’d done something terrible, they’d have sacked me up in a Singaporean jail, or deported my grand posterior. Slowly, though, I was getting there; two months, then three… finally, toting six suitcases and a lead-heavy Yamaha bass guitar (I am young at heart), I was there, inching towards the airline counter. I handed in my passport: flight to Chiang Mai, please.
“We have no record of a ticket, sir.”
But I have confirmation right here… don’t I? What’s the expression about a bridge too far? I came up a mouse click too short.
I’d planned the trip online, completed the itinerary, even printed it out. You know what? Those things look confoundingly like e-tickets. Distracted by the paper chase, I never went back and clicked one last time to ‘buy it’. It was the dunciest thing I’ve ever done. So there I stood, sweating like a monkey in a morning suit. That’s what I do in the tropics.
As the man said, my credit is spotless. I was strapped with credit cards like a bandito in bandoliers. Seats were available; the ticket counter was yonder; it only cost me double. It shows you: all that effort, nearly undone by what folks in the sixties innocently called a ‘boner’. That’s just how I felt.
To distract from my shame, let’s turn back to ILITs. Irrevocable life insurance trusts are designed to get life insurance assets, permanent or term, off of your books.
The grantor creates the trust; the trustees control it, forever; the beneficiaries benefit when the grantor passes on. When the trust takes the policy, the grantor loses control and cannot serve as the ILIT’s trustee. They can’t even pay premiums directly: that’s done via gifts to the trust, and there are workarounds to keep grantors from maxing out their gift tax exclusion. Once established, the ILIT is irrevocable – it cannot be changed or cancelled.
There are great benefits. An ILIT can help reduce estate taxes, a hot-button worry today. Beneficiaries receiving state aid, say for disability, might be disqualified by a death benefit windfall; ILIT trustees can limit disbursements to keep them under the cutoff. ILIT assets are protected from creditors, at least to the extent defined by state law. The payouts can be measured to match need or defined situations, as the structuring potential for fine-tuning an ILIT to family peculiarities is nearly infinite.
ILIT beneficiaries can be anyone: children, family members, friends or a charity. They’re a good way to care for minor kids or a surviving spouse who lacks money management skills. The ILIT can make steady payments to beneficiaries from the death benefit, all while preserving the tax advantages of life policies.
Naming a close friend or relative as the ILIT’s trustee seems natural, but is often a misstep. It can work out if the chosen party or parties have financial or legal expertise. Still, a trust needs a team to run it: tax lawyers, accountants and investment professionals to start. Professional trust management companies house all the necessary specialists and are often the most economical and trustworthy way to proceed.
An overlooked advantage: trust management firms sometimes have affiliate offices in states where income and capital gains taxes are low, allowing the ILIT to be tax-advantageously home ported. Complex estates bring burdensome record keeping and must endure audits by banks and regulators. It’s a tough gauntlet to run for individuals, while trust management firms are built to handle the load.
The first step in creating an ILIT is to hire an estate attorney – no solo flying here. It will be expensive, one or two thousand dollars, but consider: an incorrectly constructed trust is invalid. Who knows when a regulator or the IRS will bring this bad news? Remember, while your heirs prepare to march into court, you won’t be there to straighten things out.
A client’s estate planning team – financial advisors, lawyers, insurance agent – must be quickly introduced to the estate attorney. They’ll have plenty to discuss, tax issues foremost.
Next, choose that trustee, personal or professional as suits. When the trust is formed, the client’s insurance agent must amend the life policy, naming the ILIT as owner and beneficiary. Trust agreement copies must be given to all accountants or financial planners working for the estate. Paperwork, paperwork.
Did you catch it? Our potential for disaster, that unclicked icon, the embarrassing tale to taunt us and haunt us? It is strikingly common for a grantor to carry out all of these tasks, plan with exquisite care and pay the expenses – and then forget to tell their insurance agent to change the life policy’s ownership and beneficiary to the ILIT.
You’d think with all these clever boffins on the case, simple mistakes would get caught. No: it’s a straightforward job, it must have been vetted by somebody else, we all think. That’s how it happens, and you’re on the spot. It’s a simple job, indeed, sitting right in your lap – just where you don’t want anything to bite. So take care.