Life insurance provides liquidity to larger estates. At death, life insurance proceeds are available to satisfy the immediate needs of your family, as well as any estate tax (due within nine months of the decedent’s death) that may be due. Unfortunately, the face value of life insurance is included in your gross estate, exposing the proceeds to estate tax. The solution is to create an irrevocable trust to be both the owner and beneficiary of the policy.

Irrevocable trusts are a valuable estate planning tool for larger estates. They are used to remove assets like life insurance from estates that would otherwise be taxable. Unlike revocable trusts, which may be amended or revoked at any time during the grantor’s lifetime, irrevocable trusts may not be amended or revoked. Also, unlike revocable trusts, the grantor of an irrevocable trust may never act as trustee. Thus, once established, the grantor of an irrevocable trust relinquishes complete benefit and control of the trust.

As noted in Chapter Nine, your taxable estate consists of assets over which you exercise control at the time of your death. By relinquishing all such control in an irrevocable trust, you are able to exclude handpicked assets from federal estate tax. To avoid having the irrevocable trust assets leech back into your estate, you must also permanently forego the benefit or use of irrevocable trust assets.

Accordingly, when selecting assets to contribute to an irrevocable trust, you must select assets over which you are willing to permanently relinquish all control or enjoyment. Life insurance makes an attractive irrevocable trust asset, since the true value of life insurance is not realized until your death. Consequently, the fact that the policy is outside your control has little economic impact on you during your life.

To avoid adverse gift tax consequences, strict procedures must be followed when making life insurance premium payments. Since the irrevocable trust is the owner of the policy, premium payments are no longer your responsibility.

They become the responsibility of the trustee. Gifts of cash must be made to the irrevocable trust to allow the trustee to make premium payments. Transfers to the irrevocable trust are considered gifts to others since by definition you cannot be a beneficiary.

As noted in Chapter Nine, you may make gifts of $10,000 per beneficiary per year without incurring gift tax. However, in order to qualify for the gift tax exclusion, gifts must be of a “present interest.” For a gift to be of a present interest, the beneficiary must be able to enjoy the gift currently.

A transfer of life insurance premium payments to an Irrevocable Life Insurance Trust (“ILIT”) is not by itself a gift of a present interest, since the beneficiaries of a typical ILIT don’t receive a right to trust assets until the death of the grantor. However, gifts in trust are converted from future to present interest transfers by a device known as a “Crummey Notice.”

A Crummey Notice is given to all ILIT beneficiaries contemporaneously with each contribution to the ILIT. The Crummey Notice notifies each beneficiary of his or her right to withdraw his or her prorata share of the contribution. Under the terms of the ILIT and the Crummey Notice, if such right of withdrawal is not exercised within thirty days, it lapses. Despite numerous attacks by the IRS, the courts have consistently upheld the Crummey Notice as a valid means of qualifying gifts to an irrevocable trust as present interest gifts.

The following is a sample Crummey Notice:

It is the responsibility of the ILIT trustee to make annual life insurance premium payments. The insured/grantor should not make premium payments directly to the insurance company (bypassing the ILIT), as this could cause inclusion of the proceeds of the policy in the insured/grantor’s estate at death.

Instead, once the 30 day Crummey Notice period has lapsed (presumably no beneficiary has elected to withdraw their share of the annual contribution), the ILIT trustee may then make the annual premium payment to the insurance company.

Note that it is inadvisable to name either the grantor or the grantor’s spouse as trustee of the ILIT. As trustees, the grantor or grantor’s spouse would have powers considered to be “incidents of ownership,” causing the life insurance proceeds to be included in their estates. Accordingly, it is common practice to appoint other ILIT beneficiaries (such as grantor’s children) as Trustee.

The complex operation of an ILIT, and the flow of premium payments is summarized by the following illustration: