Author: Suzanne Shier
“Insurance.” The word itself evokes different reactions. The range of emotions expands when we mention “life insurance.” And if we add, trust – “life insurance trust” – you may just stop reading. But don’t. Now is exactly the time to think of planning with an irrevocable life insurance trust, whether you are an insured individual or a trustee.
Why think “life insurance trust” now?
Protect and preserve wealth. As the tide of increasing estate tax exclusion levels turns, which we expect it to do by 2022, more estates will become taxable. In 2019 (the last year for which data is available) when the estate tax exclusion was $10 million, adjusted for inflation, the IRS reported 2,570 taxable estate tax returns filed. In 2016, the final year of the $5 million adjusted for inflation exclusion amount, 5,219 taxable estate tax returns were filed, more than twice the number in 2019. In 2009, 14,713 taxable returns were filed, under the old $3.5 million exclusion amount.
Whether the current $11.7 million exclusion reverts to $5 million adjusted for inflation, $3.5 million not adjusted for inflation, or some other lower-than-current level, more estates will owe estate tax. Life insurance is a source of liquidity in taxable estates. Life insurance held in a well-designed and administered irrevocable life insurance trust can at once be excluded from the taxable estate and provide overall liquidity to the family balance sheet.
Leverage planning. Amid the flurry of tax proposals, we have yet to see a proposal that would do away with the annual gift exclusion ($15,000 in 2021) in its entirety. The annual exclusion has been part of the Tax Code for decades and we expect it to remain (although some of the details may change). Leveraging the annual gift tax exclusion will become more important as the lifetime exclusion decreases. The annual gift tax exclusion, applied to cover annual premium payments in an irrevocable life insurance trust, is an effective means of leverage, so long as the total premiums paid do not exceed the benefits paid on the policy.
Simplicity. Do we really mean simplicity? Yes, in a sense. For an irrevocable insurance trust to work to remove assets from the insured’s estate, attention needs to be paid to the administration of the trust during the insured’s lifetime. This work of the trustee comes with associated duties and liabilities. In Illinois and certain other states, state law has been modernized to simplify trustees’ investment duties and minimize the associated liabilities of a trustee during the time the policy is held in trust and the insured settlor of the trust is still living. In Illinois, for example, during the settlor insured’s lifetime, the trustee may hold an insurance policy in trust without determining that the policy is a proper investment for the trust, without diversifying the investments of the trust, and without monitoring the financial and physical condition of the insured. These are important considerations for both individual and professional trustees given the unique attributes of life insurance as an asset of an irrevocable trust.
Life insurance held in an irrevocable insurance trust has generated less interest in recent years as the estate tax exclusion amount has increased and the number of taxable estates has decreased. But now is different. With equity markets that have reached levels few anticipated, and estate tax exclusion amounts likely to decline, now is the time to think again about life insurance and irrevocable life insurance trusts to protect and preserve family financial well-being.