Introduction to Irrevocable Life Insurance Trusts (ILITs) - Part 3
The typical ILIT would be set up as follows:
-Grantor signs ILIT document, with grantor's spouse as trustee, and spouse and children as beneficiaries
-Grantor makes annual contributions to the ILIT, and trustee gives notice of contribution to beneficiaries
-Trustee purchases whole life insurance policy on grantor's life, and uses annual contributions to pay premiums
-When grantor dies, death benefit is paid to trust
Does an ILIT always have to work this way? Not really. Four variations on a theme:
1. Instead of setting up an ILIT, grantor gives money directly to his children, who collectively purchase a life insurance policy on the grantor's life. When grantor dies, the children split the death benefit. This variation isn't used very often, mostly (in my opinion) because it seems a little uncomfortable for all parties involved. But the big advantage: no need to have an attorney involved.
2. The trustee purchases a term life insurance policy instead of a whole life policy. The premiums will be lower, but the "danger" (is that the right word?) is that grantor may not die during the term of the policy, thereby making the value of the ILIT disappear.
3. The grantor transfers a current policy (or policies) to the ILIT instead of having the trustee purchase a new policy. This may be necessary if the grantor is now uninsurable, but the downside is what's known as the "three-year rule": if you transfer a whole life insurance policy to an ILIT and die within three years of the transfer, the insurance proceeds are included in your estate for estate tax purposes (as a gift made "in contemplation of death").
4. How about a 1/2 ILIT, 1/2 gift trust hybrid? By this I mean that (to take one possibility) one-half of grantor's contribution is used to purchase life insurance on the grantor's life, and the rest is invested by the trustee. Now you have the protection of the insurance if grantor dies in the near future, and the protection of appreciating investments if grantor doesn't.
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