Irrevocable Life Insurance Trusts and the Power of Gifting

By Jim Farmer and Lori McGuire, CLU, ChFC

In the previous issue of BB&T Wealth, we discussed ways to use life insurance to preserve and transfer assets. In this article, we’ll take a closer look at one of the most popular and effective vehicles: an Irrevocable Life Insurance Trust (ILIT). We will also discuss the Dynasty Trust, which further enhances asset preservation. For both techniques, we will stress the importance of moving quickly to take advantage of the opportunity to move an unprecedented amount of assets out of your estate, available only through December 31, 2012, as a result of the 2010 Tax Act.

ILITs and Dynasty Trusts are particularly suitable for those who are likely to have an estate tax liability and for those who wish to provide a legacy for future generations. The clock is ticking on the scheduled expiration of the current $5 million lifetime exclusion.

How can my family benefit from an ILIT?

For those facing a potential estate tax liability, an Irrevocable Life Insurance Trust can accomplish several important goals. These include:

  • Substantially increasing the legacy to your beneficiaries without increasing your tax liability—and doing so for pennies on the dollar.
  • Continuing to reduce your taxable estate during your lifetime by using your annual gift exclusion (currently $13,000 per individual per beneficiary) to make gifts to the trust.
  • Ensuring that assets are distributed according to your wishes by adding a spendthrift provision and granting the trustee discretion to make responsible distributions to trust beneficiaries, such as money to fund education, business endeavors and the like.

How does an ILIT work?

The grantor (an individual or couple) works with an attorney to establish an Irrevocable Life Insurance Trust and then selects a third-party trustee, either an individual or corporate entity. The trust purchases and is the beneficiary of a life insurance policy(s) on the life or lives of the grantor(s). Gifts are made to the trust by the grantor, which the trustee uses to pay policy premiums.

It is also possible to transfer the ownership of existing life insurance policies to the ILIT. Note, however, that the grantor must live for at least three years from the date of transfer to the trust to avoid inclusion of policy proceeds in his or her taxable estate.

Upon establishment of the trust, the grantor should have no incidents of ownership of the trust or the life insurance policy. Any incidents of ownership will result in a larger taxable estate and therefore a larger tax liability.

Annual exclusion gifts can be used to transfer assets into the ILIT. The annual exclusion amount is currently set at $13,000 per person, per beneficiary (for married couples, the amount doubles to $26,000). Annual exclusion gifts are typically used to pay for policy premiums to avoid a gift tax liability.

Other assets can also be held in the ILIT, and income-producing assets such as stock can be used to pay premiums. For the remainder of 2012, larger gifts up to $5 million per individual can be made to an ILIT in order to fund the life insurance and remove additional assets from the taxable estate.

Upon the death of the grantor, the trust will receive the policy death benefit free of income and estate taxes, and the trustee will then distribute assets to the beneficiaries in accordance with the wishes of the grantor. The trustee may also use the proceeds to purchase illiquid assets from the estate, providing the resources to pay estate taxes without having to force the sale of important assets such as real estate or business interests.

To show the power of the gift, consider the case of a married couple, both age 65 and in good health. They make a $1 million gift into an ILIT, and the trustee uses the funds to purchase a second-to-die life insurance policy. The $1 million gift is used as a single premium to purchase a guaranteed death benefit of $4,794,675. The couple has not only reduced the amount of their taxable estate by $1 million, they have also substantially increased the assets available to their beneficiaries.

The Importance of Taking Action Before Year-End

Signed into law by President Obama on December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Act) provided a way for many to give the perfect gift. The new law provided sweeping changes to the rules regarding federal estate taxes, gift taxes and Generation-Skipping Transfer Taxes (GSTT), but only for the 2011 and 2012 tax years.

Under the 2010 Tax Act, an individual is permitted to gift up to a lifetime amount of $5 million ($10 million for a married couple) without incurring federal estate, gift or GST taxes. This temporary $5 million lifetime exemption is scheduled to expire at the end of 2012 and will revert to the previous $1 million on January 1, 2013, unless Congress acts. This window of opportunity can significantly benefit those with large estates, providing the ability to remove a significant amount of assets from their taxable estate.

The Mega Gift: A Dynasty Trust

Another way to maximize the use of the $5 million exemption is to create a Dynasty Trust and allocate the Generation Skipping Transfer Tax exemption to the trust prior to end of 2012. This can be an extremely powerful estate planning tool for affluent clients.

The GSTT is a federal tax imposed on large amounts of money given outright or left in trust to a grandchild or great-grandchild, thus skipping a generation. Because future growth is not subject to estate, gift or the GST tax, the Dynasty Trust can in effect become a “family endowment fund” for future generations. A grantor can establish a Dynasty Trust using up to $5 million in

GSTT and gift tax exemptions. The Tax Act of 2010 reunified the exemption amounts, allowing for the same GSTT exemption amount of $5 million per individual ($10 million for married couples).

The Dynasty Trust is often referred to as a Family Bank because like a bank, the trust is a prime resource for funding the particular needs of the various beneficiaries in successive generations.

If you would like to learn more about how these techniques may fit into your personal financial plan, please contact your BB&T Wealth Advisor. The BB&T Wealth team works closely with BB&T Insurance Services specialists who have the expertise to find a customized insurance solution specific to your needs.

Note: With the inflation adjustment, the gift exclusion and GSTT exemption are $5,120,000 in 2012. We have chosen to use $5,000,000 in this article for simplification of discussion. ILITs and Dynasty Trusts are particularly suitable for those who are likely to have an estate tax liability and for those who wish to provide a legacy for future generations. The clock is ticking on the scheduled expiration of the current $5 million lifetime exclusion.

Jim Farmer

Jim Farmer is the Chief Financial Insurance Executive Officer of BB&T Insurance Services. He is responsible for the Life and Financial Planning, Title and Employee Benefits division for BB&T Insurance. He is a Life and Qualifying member of Million Dollar Round Table—a well-known organization in the insurance industry—and is a Top of the Table qualifier. Jim has been with BB&T for 30 years. He holds a BS in Business Administration from Atlantic Christian College/Barton College and is involved in a variety of civic activities in Wilson, N.C., including past chairman of the YMCA Board and current co-chairman of the “Y” Collaboration and Building committee.

Lori D. McGuire, CLU, ChFC

Lori D. McGuire, vice president, has worked for BB&T for 18 years. A member of the Life and Financial Planning Division, she specializes in life insurance as it relates to estate planning, business succession planning and high level personal planning. Her professional industry recognized designations include Chartered Life Underwriter (CLU) and Chartered Financial Consultant (ChFC). She is licensed to sell Life, Disability, Long Term Care and Variable Life products and consistently qualifies as a member of Million Dollar Round Table. Lori’s educational background includes an undergraduate degree in Marketing and a Masters degree from Marshall University in Industrial Relations.

This article originally appeared in the Spring 2012 issue of Wealth magazine.

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