Advanced Underwriting Consultants

Question of the Day – July 13

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: I have a client who has an irrevocable life insurance trust (ILIT) that owns a life insurance policy on the client’s life.  The client wants to know if he can terminate the trust and get the money from the policy.  Can he?

Answer: No, not directly.

In general, the purpose of an ILIT is to keep the life insurance death benefit from being included in the insured’s taxable estate.  In order to achieve that result, the ILIT must not give the insured any right to reach in and control its assets—including the life insurance policy.  Further, the typical ILIT has language preventing the trustee from distributing assets to the insured.  The trustee can’t distribute assets to the insured without violating the rules of the trust—and opening up the possibility of being sued by the trust’s beneficiaries.

Likewise, the insured does not have the power to terminate the trust.  That power is given to the trustee or the beneficiaries or both.

A few ILITs don’t permit the trustee to make any distributions to beneficiaries while the insured is alive.  However, some others do allow such distributions.  If a trust allows the trustee to make distributions to trust beneficiaries, that’s an indirect path to ending the trust.

Here’s an example.  Say Ricky is the insured and grantor of the trust.  Fred is the trustee, and Lucy and Ethel are the beneficiaries.  Ricky wants the trust to end, so he talks to Lucy, Ethel and Fred about his desires.  The trust document permits Fred, in his discretion, to end the trust and distribute the assets to Lucy and Ethel.  Fred does that, and so Lucy and Ethel end up owning the trust assets—including the life policy.

Lucy and Ethel can independently decide to make a gift of the life policy back to Ricky.  They are under no legal obligation to do so, and the transfer will have gift tax consequences.  However, if all parties are in agreement, the process achieves Ricky’s goals by indirect means.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.