How irrevocable life insurance trusts work

Policy rights matter beyond the owner’s name

Proceeds payable to beneficiaries other than the estate are included in the insured’s federal gross estate when the insured held incidents of ownership at death, alone or jointly with someone else.

These rights include changing the beneficiary, surrendering or canceling the policy, assigning it, revoking an assignment, pledging it, or borrowing against its surrender value.

Trustee powers can also count when they permit the insured to change beneficial ownership or the time or manner of enjoyment, even without a beneficial interest in the trust.

Applicable state or other law affects the rights analysis. Avoiding inclusion under the insurance ownership rule does not rule out inclusion under another federal estate tax provision.

Estate payment obligations need separate review

Insurance proceeds on the decedent’s life receivable by or for the estate are included in the federal gross estate, whether or not the estate is named as beneficiary.

If another beneficiary has a legally binding obligation to pay estate taxes, debts or other enforceable charges, inclusion extends to the proceeds required to satisfy that obligation.

The regulation also treats proceeds securing the decedent’s borrowing as receivable for the estate’s benefit. If local community property law makes half of estate payable proceeds the surviving spouse’s property, only the estate’s half is included under this rule.

Gross estate inclusion does not establish the amount of tax actually owed.

Transferring an existing policy

A transfer of a policy interest or relinquishment of a power within three years before death can cause estate inclusion if retaining it until death would have caused inclusion under the specified federal provisions.

Those provisions address retained enjoyment or income, certain reversions, powers to alter enjoyment, and life insurance ownership rights. A bona fide sale for adequate and full consideration in money or money’s worth is excepted.

The rule requires the decedent’s transfer or relinquishment. It does not apply solely because a trust purchased a policy within three years before the insured’s death.

Retained enjoyment, income or beneficiary designation powers also require review when retained for life, for a period measured by death, or for a period that does not actually end before death.

Premium contributions and withdrawal rights

The annual gift tax exclusion requires a qualifying present interest: an unrestricted right to immediate use, possession or enjoyment of property or its income. Future interests do not qualify, and the exclusion cannot exceed the present interest’s value.

In the Crummey case, enforceable withdrawal rights supported the exclusions allowed under the trust terms, circumstances and California law considered there. That historical decision does not establish a current nationwide state law rule, and other states differ.

Nominal withdrawal wording alone does not establish qualification. The decision also does not establish a universal statutory requirement to send written notices.

For your review meeting, gather contribution records, notices, delivery evidence, withdrawal demands, distributions and premium records. This is a recommended documentation checklist.

Donors subject to gift taxation must keep permanent records establishing their gifts, allowable deductions and information required for gift returns. They must retain documents and vouchers used to prepare returns and furnish requested supporting documents.

Loans and asset purchases require careful terms

In Minnesota, for example, trustees generally have powers to acquire property and make loans from trust property, except as limited by trust terms and subject to fiduciary duties. Other states differ.

A Minnesota trustee owes loyalty to beneficiaries and cannot place personal interests above theirs. The statute permits loans to beneficiaries on terms the trustee considers fair and reasonable under the circumstances.

A transaction with a decedent’s estate in which the trustee is a fiduciary or a beneficiary has an interest is not precluded by the cited loyalty provision if fair to beneficiaries.

This does not approve every transaction. Review a proposed loan or asset purchase alongside any binding obligation to pay estate liabilities.

Two related terms

Irrevocable life insurance trust: A trust used to hold life insurance. The label alone does not establish completed gift treatment or exclusion from the insured’s gross estate.

Incidents of ownership: Policy rights, including economic rights beyond legal title.

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