Some farm clients are concerned how future beneficiaries will pay for the farm operation, and also how to equalize the distributions between the beneficiaries who are farming and those who are not.
Life insurance and an irrevocable life insurance trust (ILIT) are great tools to address those concerns.
It is common to use life insurance to pay down debts, buy out a decedent’s interest in a farm operation, or provide for beneficiaries not receiving farm assets.
Often when life insurance is used for these purposes, the policy is owned by an ILIT. One reason for using an ILIT is that the proceeds are not included in the taxable estate. This means the proceeds are not subject to estate tax. Also, the ILIT protects the policy from the risks of the beneficiaries.
For example, if the life insurance policy is gifted outright to the beneficiaries, there is the risk that the life insurance policy could be lost if the beneficiary were divorced, bankrupt or sued. The ILIT protects the policy from these risks.
An ILIT can be used for a policy that already exists, or it can purchase a new policy.
When the policy already exists, it is gifted to the ILIT. The cash value of the policy is considered a gift to the trust beneficiaries.
Some issues to consider
If the cash value exceeds the annual gift exclusion, the person giving the life insurance policy uses up a portion of his or her lifetime estate and gift tax exclusion on the 709 gift tax return. Also, under U.S. Code Section 2035(a), there will be a three-year look-back from the date of the gift. If the insured dies within the three years of the gift, the proceeds will be included in the federal taxable estate.
If the ILIT purchases the policy, this is done by creating the trust and giving money to the trustee to purchase the life insurance and pay the premiums. Once these funds are received, the trustee gives each beneficiary notice of the gifts made to the trust and the option to withdraw those funds. This is called a “Crummey notice” and is necessary to complete the gift to the ILIT.
Once the 30-day notice period is up, the trustee would then make the payment for the life insurance. In this type of trust, the proceeds from the life insurance policy are not subject to the three-year look-back rule.
In either case, an ILIT may be a good estate planning option.
Balzarini is an attorney at law with Miller Legal Strategic Planning Centers, P.A. Contact him at [email protected].