life insurance trusts

March 24, 2022

John Brennan, Senior Vice President of Trust and Financial Services at Cape Ann Savings Bank in Gloucester, Massachusetts talks with John Maher about life insurance trusts. He explains how they can help you avoid estate taxes and more. .

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Podcast Transcription:

Transcription Disclosure: Below is a transcript of the conversation between John Maher and John T. Brennan. Please note, this is an unedited "word for word" rendition of the actual conversation and is not intended to be grammatically correct.

John Maher: Hi, I'm John Maher. I'm here today with John Brennan, Senior Vice President of Trust and Financial Services at Cape Ann Savings Bank in Gloucester, Massachusetts. Today, our topic is life insurance trusts. Welcome John.

John Brennan: Hi John.

What Is a Life Insurance Trust?

John Maher: John, what is a life insurance trust?

John Brennan: Okay, so a life insurance trust, first of all, life insurance trusts have their own nickname, which is ILITs. The “I” is irrevocable life insurance trust, ILIT, so that's the shorthand we have for them. A life insurance trust is a special type of irrevocable trust. An irrevocable trust means you can't change it. It has its own tax ID or social security number. What happens is this type of trust owns and holds a life insurance contract most likely on the life of the person who created it.

How Do You Operate a Life Insurance Trust?

John Maher: Okay. How do you operate a life insurance trust?

John Brennan: What happens with a life insurance trust is the trust will own the policy. Okay? There's a complicated thing called incidents of ownership around life insurance policies that you have to be careful with of the creation of this trust. What happens is you want the trust to own the policy, not a person. Then each year, well, what happens with life insurance, John? What's something you know that has to happen with life insurance? Pay the premium, right?

John Maher: Right.

John Brennan: Okay, so that happens on an annual basis. What happens is you have a trust which owns a life insurance policy. Then once a year, there are certain beneficiaries of this trust, okay? Future beneficiaries of this trust and the trust creator puts in, say, $10,000, an amount that's below the gift tax exemption. Okay? Let's call it $10,000. The trustee of the trust says to maybe the four kids of the trust creator, "Hey, I just got a gift of money into this policy. Do you want it? Do you want to come and extract it, or do you want to sign here on this piece of paper and send it back to me that says essentially, '"No, thanks". You go ahead and do whatever you will with that money.'" Then, what happens is after the sign off, the trustee takes the money and pays the policy premium. The policy premium stays in effect for another year. Okay?

Then, what happens is that the insured individual dies, the trust receives all of those policy benefits and then does whatever the trust says to do vis-à-vis the beneficiaries… hold it for their benefit, distribute them income, distribute it outright, whatever that may be.

Pros and Cons of a Life Insurance Trust

John Maher: Okay. What are some of the pros and cons of a life insurance trust like that?

John Brennan: The big pro of this type of trust is it is outside of the decedent's estate. Okay? Remember, the trust owns the policy, the trust operates the policy. Then, at death, the only overlap with the individual is the fact that they were the insured, but that does not create a taxable event. It means that someone could have a five million dollar life insurance policy benefit that hits their trust that is entirely outside of their taxable estate.

Who Should Use a Life Insurance Trust?

John Maher: Okay, so explain who a life insurance trust is used for.

John Brennan: Well, it's used for a lot of people. Okay? The main thing is tax avoidance. If you have an estate tax problem, okay, if you're concerned about the estate tax, this might be a good way to transfer value out of your estate by probably paying a large premium, and then also making sure that some of that benefit winds up with your heirs, even though it's not coming directly from you.

It's sort of coming around you. These types of trusts were more popular when the estate tax thresholds were lower. They're much higher now… in the terms of tens of millions, so you don't see these quite as often. When they were much lower, these were, I would say, almost a common type of trust because it's a very useful way of getting money from being taxed by the estate tax.

How to Set up a Life Insurance Trust

John Maher: All right. Can you just briefly explain how somebody would go ahead and set up a life insurance trust?

John Brennan: What you do to create a trust, many attorneys in estate planning are familiar with it, so what happens is you create that trust. You would have the life insurance either purchased by the trustee or transferred into the trust. Then, what happens is once the trust is managed, the thing you have to be aware of, there's a little bit of that complexity because the back and forth that I described where you say, "Hey, the trust is in receipt of the gift and send in the letter," that's an audit trail. That is something that's allowed under Internal Revenue Service codes, that's called Crummey powers. Okay?

You have to be able to show that you maintained that gifting and you maintained that throughout the life of the trust, just to make sure that the ILIT will not be counted as part of the decedent's estate. The other thing you have to be aware of just vis-à-vis these types of trusts, somebody's got to know what's going on insurance wise because insurance policies can go south. Insurance companies can go south. Somebody's got to make sure that policy is going to be there when somebody passes away and that can require some expertise. Go ahead.

Who Should Manage a Life Insurance Trust?

John Maher: Yeah. Who should manage a life insurance trust then?

John Brennan: I think a professional trustee personally. I mean we have a chassis for it here. We're used to it. We audit those policies every year. It's like a lot of things in the trust world, it's hard enough, but it's not rocket science, but it has to be right. It has to be right. You have to be able to show that you did what you said you did, say, even 15 years ago or something like that, so record keeping and organization are required.

John Maher: All right. Can you go ahead and summarize your thoughts on life insurance trusts for us?

John Brennan: Like I said, John, great tool for the right circumstances. If the estate tax thresholds come down, you're going to see more of these trusts come up. We definitely have some now. Like I said, great for lowering the estate tax, okay? And creating an independent gift out there when you get to the point where you have a large estate and you're thinking your baseline is taking care of ILITs and probably the next thing you're going to build out for.

Contact Cape Ann Savings Bank to Talk About Life Insurance Trusts

John Maher: All right. Well, that's really great information, John. Thanks again for speaking with me today.

John Brennan: You got it, John.

John Maher: For more information, contact Cape Ann Savings Trust and Financial Services at 978-283-7079 or visit the website at capeannsavings.bank.

Investments purchased through the Cape Ann Savings Trust and Financial Services department are not FDIC insured, not FDIC guaranteed, not bank guaranteed, and may lose principal value.