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Irrevocable Life InsuranceTrust (ILIT)

December 03, 2012

One of the main reasons we buy life insurance is sothat when we die, our loved ones will have enoughmoney to pay off our remaining debts and finalexpenses. We also purchase life insurance to providefor our loved ones' future living expenses, at least fora while. That's why it may seem unfair that lifeinsurance proceeds can be reduced by estate taxes.That's right--the general rule is that life insuranceproceeds are subject to federal estate tax (and,depending on your state's laws, state estate tax aswell). This means that as much as 35% (currently thehighest estate tax rate) of your life insuranceproceeds could be going to Uncle Sam instead of toyour family as you intend. Fortunately, properplanning can help protect your family's financialsecurity.

The key is ownershipGenerally, all the property you own at your death issubject to federal estate tax. The important point hereis that estate tax is imposed only on property in whichyou have an ownership interest; so if you don't ownyour life insurance, the proceeds will generally avoidthis tax. This begs the question: Who should ownyour life insurance instead? For many, the answer isan irrevocable life insurance trust, or ILIT(pronounced "eye-lit").

What is an ILIT?An ILIT is a trust primarily set up to hold one or morelife insurance policies. The main purpose of an ILIT isto avoid federal estate tax. If the trust is drafted andfunded properly, your loved ones should receive all ofyour life insurance proceeds, undiminished by estatetax.

How an ILIT worksBecause an ILIT is an irrevocable trust, it isconsidered a separate entity. If your life insurancepolicy is held by the ILIT, you don't own thepolicy--the trust does.

You name the ILIT as the beneficiary of your lifeinsurance policy. (Your family will ultimately receivethe proceeds because they will be the namedbeneficiaries of the ILIT.) This way, there is no dangerthat the proceeds will end up in your estate. Thiscould happen, for example, if the named beneficiaryof your policy was an individual who dies, and thenyou die before you have a chance to name anotherbeneficiary.

Because you don't own the policy and your estate willnot be the beneficiary of the proceeds, your lifeinsurance will escape estate taxation.

Caution: Because an ILIT must be irrevocable, onceyou sign the trust agreement, you can't change yourmind; you can't end the trust or change its terms.

Creating an ILITYour first step is to draft and execute an ILITagreement. Because precise drafting is essential, youshould hire an experienced attorney. Although you'llhave to pay the attorney's fee, the potential estate taxsavings should more than outweigh this cost.

Naming the trusteeThe trustee is the person who is responsible foradministering the trust. You should select the trusteecarefully. Neither you nor your spouse should act astrustee, as this might result in the life insuranceproceeds being drawn back into your estate. Selectsomeone who can understand the purpose of thetrust, and who is willing and able to perform thetrustee's duties. A professional trustee, such as abank or trust company, may be a good choice.

Funding an ILITAn ILIT can be funded in one of two ways:

1. Transfer an existing policy--You can transfer yourexisting policy to the trust, but be forewarned thatunder federal tax rules, you'll have to wait threeyears for the ILIT to be effective. This means that ifyou die within three years of the transfer, theproceeds will be subject to estate tax. Your age

An ILIT is a trustprimarily set up to holdone or more lifeinsurance policies. Themain purpose of an ILITis to avoid federal estatetax. If the trust is draftedand funded properly,your loved ones shouldreceive all of your lifeinsurance proceeds,undiminished by estatetax.

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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012

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Sentinel Solutions, Inc. is not an affiliate or subsidiary of MML Investors Services, LLC or its affiliated companies.

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is notspecific to any individual's personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purposeof avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or herindividual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believedto be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any timeand without notice.

and health should be considered when decidingwhether to take this risk.

2. Buy a new policy--To avoid the three-year ruleexplained above, you can have the trustee, onbehalf of the trust, buy a new policy on your life.You can't make this purchase yourself; youmust transfer money to the trust and let thetrustee pay the initial premium. Then, as futureannual premiums come due, you continue tomake transfers to the trust, and the trusteecontinues to make the payments to theinsurance company to keep the policy in force.

Gift tax consequencesBecause an ILIT is irrevocable, any cash transfersyou make to the trust are considered taxable gifts.However, if the trust is created and administeredappropriately, transfers of $13,000 or less per trustbeneficiary will be free from federal gift tax underthe annual gift tax exclusion. Note: $13,000 is thecurrent figure. The annual gift tax exclusion isindexed for inflation, so this figure may change infuture years.

Additionally, each of us has a gift and estate taxexemption, so transfers that do not fall under theannual gift tax exclusion will be free from gift tax tothe extent of your available exemption. The giftand estate tax exemption amount is $5,120,000(plus any applicable deceased spousal unusedexclusion amount) for 2012.

Crummey withdrawal rightsGenerally, a gift must be a present interest gift inorder to qualify for the annual gift tax exclusion.Gifts made to an irrevocable trust, like an ILIT, areusually considered gifts of future interests and donot qualify for the exclusion unless they fall withinan exception. One such exception is when thetrust beneficiaries are given the right to demand,for a limited period of time, any amountstransferred to the trust. This is referred to asCrummey withdrawal rights or powers. To qualifyyour cash transfers to the ILIT for the annual gifttax exclusion, you must give the trust beneficiariesthis right.

The trust beneficiaries must also be given actualwritten notice of their rights to withdraw wheneveryou transfer funds to the ILIT, and they must begiven reasonable time to exercise their rights (30to 60 days is typical). It's the duty of the trustee to

provide notice to each beneficiary.

Of course, so as not to defeat the purpose of thetrust, the trust beneficiaries should not actuallyexercise their Crummey withdrawal rights, but shouldlet their rights lapse.

The key duties of an ILIT trustee include:• Opening and maintaining a trust checking

account• Obtaining a taxpayer identification number for

the trust entity, if necessary• Applying for and purchasing life insurance

policies• Accepting funds from the grantor• Sending Crummey withdrawal notices• Paying premiums to the insurance company• Making investment decisions• Filing tax returns, if necessary• Claiming insurance proceeds at your death• Distributing trust assets according to the terms

of the trust

The gift and estate taxexemptions are unified.Any gift tax exemptionyou use reduces theamount of the estate taxexemption that will beavailable.

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