Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

 Question:  My client is the owner of a policy on his life. He set up an irrevocable life insurance trust (ILIT) as the beneficiary. He also named himself as trustee of the ILIT. Would this bring the insurance proceeds back into his estate at death?

Answer: The general rule under Code section 2042 is that if the insured either (1) is the beneficiary of his life insurance policy, or (2) has any right to the economic benefits of the policy—referred to as “incidents of ownership”—then the proceeds will be included in the insured’s estate at his death.

Incidents of ownership include the power of the insured to—

• Directly or indirectly to change the beneficiary or contingent beneficiary of the policy;
• Surrender or cancel the policy;
• Assign or revoke assignment of the policy;
• Pledge the policy as collateral for a loan; and
• Obtain a loan from the carrier on the surrender value of the policy.

The fact that an insured is the trustee by itself does not constitute an incident of ownership and bring the insurance proceeds into his estate at death, but various powers as trustee might. For example:

Power of substitution. If a life insurance policy is held in trust, and the insured is the trustee, he may not have the power to substitute the life policy with assets of equivalent value. See Rev. Rul. 2011-28.

• Power to remove and replace trustees of an ILIT. An insured-grantor may remove and replace the trustee of his ILIT only if the successor trustee is not related or subordinate to the grantor. See Rev. Rul. 95-58.
• Power to change beneficial ownership. An insured-grantor, as trustee or otherwise, may not change the beneficial ownership in the policy held in the ILIT without it being subject to his estate. See Treas. Reg. Sec. 20.2042-1(c)(4).
• Power to change the time or manner of the proceeds. An insured-grantor may also not have the power to alter the time or manner that the proceeds are distributed, even if the insured, himself, has no beneficial ownership of the proceeds. See Treas. Reg. Sec. 20.2042-1(c)(4).

Even though your client has no beneficial interest in the proceeds, he still may be subject to estate taxes on the proceeds if he, as trustee, holds certain powers exercisable for his own personal benefits.

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