Irrevocable Life Insurance Trusts in Estate Planning: Common Pitfalls

By way of example, assume that your client makes a gift to an ILIT of which their two children are the current beneficiaries.

Assume further that the ILIT provides that each time a contribution is made to it, the trustee must notify the children that they have the unrestricted right to withdraw a proportionate share of such contribution (up to the annual gift tax exclusion amount) for a fixed period of time from the date of the contribution (e.g., 30 days).

If the trustee fails to provide such notice, then the gift to the ILIT will not qualify as an annual exclusion gift.

Similarly, if, prior to the expiration of the fixed period, the trustee makes a disbursement from the ILIT that causes the value of the ILIT’s assets to drop below the amount subject to a withdrawal right, then the gift will not qualify for the annual exclusion.

To avoid these pitfalls, advisors should, first, review an ILIT before it is signed to confirm that it includes Crummey withdrawal rights, and, second, help their clients establish procedures for providing the requisite notice and waiting the required period each time a gift is made.

This may include setting a reminder for their clients to fund their ILIT each year on a date to allow sufficient time for the fixed period to lapse before a premium payment is due (e.g., 45 days before the premium due date if the fixed waiting period is 30 days).

Pitfall 3: Forgetting to Account for Administrative Expenses

During the insured’s lifetime, ILITs often have limited assets as they may only be funded with the insurance policy and the amount needed to cover the premiums thereon.

As a result, if the ILIT has any administrative expenses such as accounting, legal or trustee fees, there are insufficient assets in the ILIT to pay them.

If the client pays these expenses directly, they will be treated as making a gift for gift tax purposes because the client will be deemed to have first transferred to the ILIT any amounts paid on its behalf.

Thus, to avoid this issue, clients should fund their ILITs with the amount necessary to pay premiums and administrative costs.

(If the class of beneficiaries holding Crummey withdrawal rights is broad enough, this can be done solely through annual exclusion gifts.)

Clients rely on their advisors to help them identify the right insurance policy and determine how best to finance the policy in order to achieve their planning goals.

But when an ILIT is involved, advisors can add value by helping their clients avoid the pitfalls that may otherwise undermine their efforts.

Elizabeth G. Acevedo is a shareholder at Weinstock Manion.