Creating a successful estate plan is a complex and often complicated undertaking, and often becomes more so as you age and your estate value increases. Additional goals are added as both your family and your assets grow. Like most people, you probably consider providing for your loved ones to be a primary estate planning goal. If you have a moderate to large estate, avoiding estate taxes is likely another one of your estate planning goals. An Irrevocable Life Insurance Trust (ILIT) can help with both of those goals. If you choose to include an Irrevocable Life Insurance Trust in your estate plan, can you appoint a beneficiary as the Trustee of that trust?
Trust Fundamentals
A trust is a legal relationship where the property is held by one party for the benefit of another party. The person who creates a trust is referred to as the “Settlor”, “Trustor” or “Grantor.” The Settlor transfers property to a Trustee, appointed by the Settlor. The Trustee holds that property for the trust’s beneficiaries as well as invests trust assets and administers the trust terms according to the terms created by the Settlor. Trusts all fall into one of two categories – testamentary or living trusts. A testamentary trust is activated by a provision in the Settlor’s Will at the time of death whereas a living trust activates once all formalities of creation are in place and the trust is funded. Living trusts can be further divided into revocable and irrevocable living trusts. Because a testamentary trust is activated by a provision in the Settlor’s Will, and a Will can always be revoked up to the time of the Testator’s death, a testamentary trust is also revocable up to that point.
What Is an Irrevocable Life Insurance Trust?
As a general rule, life insurance proceeds pass to the named beneficiary free of any income tax; however, what many people do not realize is that the payout from a life insurance policy is generally included in the “gross estate” of the policy owner for estate tax purposes at the policy owner’s death and is potentially subject to federal and state estate taxes. At a tax rate of 40 percent, gift and estate taxes should be avoided whenever possible. An ILIT takes advantage of a loophole created by Congress. If an ILIT is created to own the life insurance policy and the proceeds of the life insurance policy are payable to the trustee of the ILIT upon the insured’s death, then the proceeds are not included in the insured’s estate and, therefore, are not taxable for federal estate tax purposes. This applies even though the insured gives the money to the trustee of the ILIT to pay the annual premiums of the life insurance policy.
Can a Beneficiary Be the Trustee of an ILIT?
The question is not whether you can appoint a beneficiary as the Trustee, but whether you should do so. The trustee of a trust has many duties and responsibilities; however, in general, a Trustee is responsible for managing trust assets and administering the trust using the terms created by the Settlor. While there is no legal impediment to a beneficiary also serving as the Trustee of an irrevocable life insurance trust, it is often not a good idea, particularly if there are additional beneficiaries as well. The likelihood of a conflict arising increases exponentially under such circumstances. By the same token, the Settlor cannot be the Trustee because that results in the Settlor having an incident of ownership in the life insurance policy which, in turn, means that the policy proceeds would be taxed in the estate of the Settlor upon his or her death.
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