Can’t I just give my life insurance policy to someone instead of creating an ILIT?
Questions frequently asked are, “Is it really necessary to go through all of the steps needed to create and transfer life insurance to an ILIT? Wouldn’t it simply be easier to remove the insurance from my taxable estate by gifting the policy to my spouse or another family member?” Although gifting a life insurance policy to someone else to remove it from your taxable estate is possible, there are a myriad of problems with someone else owning your policy.
First, when the policy is transferred to an individual, the same gift tax consequences must be considered that exist when transferring it to an ILIT. The steps taken in creating an ILIT make sure these gift tax issues are not overlooked.
Second, if a spouse or adult child owns a policy on your life, and he or she dies first, the policy’s value may cause an estate tax problem in his or her estate. Using an ILIT can significantly reduce or even eliminate the estate tax specter—not merely shift the tax burden from one person to another.
Third, when you transfer a life insurance policy to another person you lose all legal control over it. The new owner can change the beneficiary, take the cash value, or even cancel the insurance. Creating an ILIT where your chosen trustee is required to follow your instructions concerning use of trust assets can prevent this. A trustee will be responsible for paying premiums and is more likely to keep the policy in force than would a child or children when called upon to write a check for the premium.
Fourth, when insurance is transferred to individuals the beneficiaries usually receive the proceeds as an outright distribution at your death. Your family would lose all of the distribution protections that exist when life insurance is transferred to an ILIT. These protections include the following:
- If your children are underage they cannot accept ownership of any death benefits. If a minor child is named as a beneficiary of a life insurance policy, the insurance company will not pay the proceeds to the child. It will instead force the matter into probate court where the court will probably order the proceeds held in trust until the child’s eighteenth birthday. The child will then receive a cashier’s check for the remaining balance. This would not happen with an ILIT, which would allow you to maintain control over when and how children receive the proceeds;
- The death of a trust beneficiary will not result in the premature transfer of the policy to his or her spouse or minor child;
- Children may have asset protection from creditors, lawsuits, and divorcing spouses when life insurance is placed in an ILIT;
- An ILIT guarantees that the administrator of your estate will have liquidity needed to pay expenses and coordinate the administration of your estate;
- ILITs permit the use of generation-skipping transfers, a method used to pass unspent proceeds of the insurance from generation to generation without incurring taxes, that are not available with an outright distribution.
In summary, creating an ILIT that meets your objectives and fits into your overall estate plan requires careful planning and the assistance of an insurance professional and estate planning attorney. If properly established and implemented, it is an excellent way to help create an estate, protect an estate from unnecessary taxation, and most importantly, provide a lasting legacy for your loved ones.