Advanced Underwriting Consultants

Question of the Day – June 20

Ask the Experts!

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

Question: One of my clients is thinking about buying a life insurance policy that has an accelerated death benefit feature for chronic illness.  The client also wants the insurance to be excludible from his taxable estate through ownership by an irrevocable life insurance trust.  How can I help make that work?

Answer: It’s probably not a good idea to combine ILIT ownership of a policy when the insured wants to access the chronic illness rider.

Many riders are designed to be triggered by the insured being unable to do 2 of 6 ADLs.  Where the insured is the owner of the contract, it seems clear that the benefits are tax free when paid to the insured up to $300/day in 2011, or actual long term care expenses if greater.

To be effective for estate tax reasons, an irrevocable trust must not permit the insured to have any right to the assets in the trust.  If the trustee is permitted to make lifetime chronic illness distributions to the insured, or for the insured’s benefit, it puts the estate tax effectiveness at risk.

It is possible to use one or more the trust beneficiaries–including spouse, if desired–as potential conduits for chronic illness payments back to the insured.  There are two important drawbacks to this:

  • first, there can be nothing agreed in advance that the beneficiary is under any obligation to access money for the insured, and
  • second, the benefit paid may be taxable.

In general, because of the potential for family uncertainty or estate tax risk, we don’t recommend that anyone who wants to use the chronic illness rider put the life insurance in an irrevocable trust.

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.