Many clients are shocked to find out that the life insurance policies they own at death are includable in their estate when determining whether a Federal or Massachusetts estate tax return must be filed. In Massachusetts, an estate tax return is required to be filed when an individual passes away owning over $1,000,000 in assets. If that individual owns one or two life insurance policies on their life, and a piece of real estate, it does not take much else to meet the Massachusetts filing threshold. You may be asking yourself, “well if I name a third-party beneficiary, why would the life insurance policy be in my estate?” That is a valid question, and the short answer is that both the MDOR and IRS deem the fact you can change the life insurance policy’s beneficiary enough of an ownership interest in the policy, that the policy is a countable asset.
However, there are ways to avoid the inclusion of life insurance policies in your taxable estate. A great mechanism to utilize is an Irrevocable Life Insurance Trust. The basic premise is that a grantor establishes the trust and transfers the life insurance policy into the trust. At the same time, the grantor would transfer monetary funds into the trust, so that the trust can pay the insurance premiums moving forward. Upon the death of the grantor, the policy would pay to the trust free of federal and state estate taxes. The trust would then distribute the proceeds in accordance with the trust document.
When prepared properly, an Irrevocable Life Insurance Trust, or ILIT, can provide income for the family, provide funds for estate settlement costs, avoid increases in estate taxes and probate costs, provide for the management of assets, and take advantage of gift tax laws.
The transfer of the policy into the trust can have gift tax implications. However, if the trust is properly drafted with “Crummey” powers (based upon the court ruling in Crummey v. Comm’r 397 F2d. 82 (9th Circuit 1968) then the annual gift tax exclusion is applicable if the beneficiary has an unrestricted right to the immediate use, possession, or enjoyment of the property or the income from the property. This exclusion is applicable regardless of whether the beneficiary actually exercised the right.
What is a Crummey power? In order for the Crummey power to qualify for the gift tax exclusion, the beneficiary must be given 1. A beneficial interest in the trust, 2. Notice of the right of withdrawal, and 3. A reasonable time to exercise this right before it lapses.
What is a beneficial interest? Any individual who has a present interest right to participate in any income or principal distribution contained in the trust document is considered to have a beneficial interest. The individual must have both a right to withdraw and other rights to the trust. Simply giving an individual the right to withdraw without any other interest is likely to fail. Similarly, the IRS has ruled that the grantor of an ILIT should not be entitled to the annual gift tax exclusion for any beneficiary who may have withdrawal rights but only a contingent interest in the trust.
What is a notice of the right to withdraw? The IRS and Tax Court have indicated that the trust beneficiaries must not only be informed of their right of withdrawal but also of the amount of the contribution into the trust and the amount of the beneficiary’s withdrawal right. If the trustee fails to provide this information in the notice, then the annual gift tax exclusion would fail.
What is the reasonable time to exercise the right of withdrawal? The IRS through its private letter rulings has held that 30 days is a reasonable time between the date of notice to the beneficiary and the lapse of the right.
Lake Shore Legal
Utilization of an Irrevocable Life Insurance Trust can be an effective method to avoid federal and state estate tax exposure. Our attorneys can explain in more detail the advantages of this trust to both you and your family. Further, our attorneys are experienced in properly drafting these trusts so that not only is the life insurance policy excluded from your estate but you also avoid any and all gift tax exposure concerning the transfer.
Contact Lake Shore Legal today and allow our attorneys to assist you with proper estate planning. Proper estate planning can ease the burden upon both you and your family in the future. Contact us today. info@lakeshorelegalsolutions.com; 508-943-7800