Friday April 26, 2024

2.3.2 Gift and Insurance Trust

Current Charitable Gifts

Gift and Insurance Trust:  A charitable gift may be combined quite effectively with a life insurance trust. The gift of appreciated property removes assets from an estate and provides a current income tax deduction.

Irrevocable Life Insurance Trust:  An ILIT is an irrevocable trust designed to use insurance as the principal trust investment.

The Crummey Power:   In funding the ILIT, a grantor generally desires to use the available gift exclusions.

Gift Tax Results:   Most donors will prefer to use sufficient annual exclusions to cover the gift to the ILIT.

Insurance Policies:   An ILIT usually holds some type of permanent insurance policy. This could be a full life, a universal life, a variable universal life or a survivor version of any of these plans.

Insurance Policy Illustrations:   A chartered life underwriter can explain the illustration of the insurance benefits to the donor.

Gift and Insurance Trust Procedures:  Since the inheritance for the family is contingent upon successful creation of the insurance trust, it is preferable to conduct the physical, go through the underwriting process with the insurance company and issue the policy.

Gift and Insurance Trust


A charitable gift may be combined quite effectively with a life insurance trust. The gift of appreciated property removes assets from an estate and provides a current income tax deduction. The accompanying Irrevocable Life Insurance Trust (ILIT) allows the donor to create an inheritance for the family in a very tax-advantageous manner. The gift of appreciated property both bypasses capital gain and produces a charitable deduction. Normally, this gift of a long-term capital gain asset qualifies for a deduction at fair market value, usable to 30% of AGI and with a five-year carry forward. Sec. 170(b)(1)(C).

Irrevocable Life Insurance Trust


An ILIT is an irrevocable trust designed to use insurance as the principal trust investment. In the case of an ILIT created to provide inheritance for family members, the trust normally will receive one or more gifts of cash from the grantor and will use those gifts to pay the premiums on an insurance policy.

An irrevocable trust is essential, since a key goal is to avoid its inclusion in the estate of the trust grantor. In order to avoid this inclusion, the trust proceeds are not payable to the estate, and the grantor retains no "incidents of ownership." Sec. 2042(2). Incidents of ownership include rights to designate beneficiaries under the policy, to borrow against the policy, to a reversion from the policy, or to control the policy in any manner. With an ILIT, the trust grantor relinquishes all rights to the policy in order to avoid any incidents of ownership.

The Crummey Power


In funding the ILIT, a grantor generally desires to use the available gift exclusions. If the available gift exclusions are exceeded, the grantor may also use a portion of his or her applicable gift exemption to cover the transfer to the trust. However, under Sec. 2503(b)(1), the gift exclusion is available only if it is a "present interest." In order to qualify for the present-interest transfer, the ILIT document will include a "Crummey" power. The Crummey power allows each beneficiary to withdraw an amount (usually up to the gift exclusion) for a period of 30 to 45 days. After that, the right lapses and the funds may be used to pay insurance premiums. Crummey v. Commissioner

If the Crummey power is limited to a withdrawal right of the greater of $5,000 or 5% of trust corpus, there is no tax consequence upon the lapse of the power. Sec. 2041(b)(2). However, if the lapse exceeds $5,000, it may be appropriate to create a "hanging" Crummey power, or give the beneficiary a special inter vivos or testamentary power of appointment over the excess amount.

Another option is to provide a Crummey power to a contingent beneficiary, such as a grandchild. Cristofani v. Commissioner Under the rational of the Cristofani case, a contingent beneficiary may also hold a Crummey power and allow it to lapse. This option expands significantly the number of potential holders of Crummey powers.

Gift Tax Results


Most donors will prefer to use sufficient annual exclusions to cover the gift to the ILIT. If there are not sufficient numbers of gift exclusions using the Crummey powers and, potentially, Cristofani contingent beneficiaries, there are two choices. First, the gift to the trust may be made over two or more years to make use of the available annual exclusions each year. Alternatively, the donor may elect to make a larger transfer and use a portion of the gift exemption for the excess over the gift amount equal to the number of available annual exclusions.

Insurance Policies


An ILIT usually holds some type of permanent insurance policy. This could be a full life, a universal life, a variable universal life or a survivor version of any of these plans. The variable universal life policy is attractive, since the underlying portfolio of stocks and bonds could increase in value and may result in greater benefit to heirs.

Gift planners are urged to work with qualified life underwriters in selecting the policy. It will be necessary for the donor to obtain a physical and receive assurance that the insurance company is willing to underwrite the policy. In order to determine the financial viability of the company, the life underwriter should disclose the ratings of the insurance company. Ratings are available from A. M. Best, Moody's, Standard and Poor's and Duff and Phelps. A company with very high ratings is understandably preferred.

For a married couple, it is frequently advisable to request an illustration for a second-to-die policy. Even if one of the two parties is rated due to health reasons, many companies will issue a second-to-die policy, with modest additional expense. The assumption of the insurance company actuary is that the healthy spouse will live to normal life expectancy. Thus, the policy is available at a reasonable cost.

Insurance Policy Illustrations


A chartered life underwriter (CLU) can explain the illustration of the insurance benefits to the donor. The insurance policy is simple in concept and complex in implementation. The simple concept of insurance is that large numbers of individuals can contribute premiums. These are invested by the insurance company and will make a payment of death benefits at the maturity of the individuals. Since the number of insured is quite large, the average maturity or life expectancy can be determined. If the policy investments are successful, there will be increased funds for the insurance company and, in some cases, for the insured. Conversely, if the investments produce less than the desired return, benefits may be reduced.

For this reason, the CLU should explain the assumed earnings rate within the policy. If a variable universal life policy earns less than anticipated, the donor may have to pay higher premiums or premiums for a longer time than initially estimated. Many of the newer insurance policies, such as the variable universal life, offer potentially greater returns but do include some investment risk. This investment risk must be disclosed to the donor.

Gift and Insurance Trust Procedures


Since the inheritance for the family is contingent upon successfully creating the insurance trust, it is preferable to conduct the physical, go through the underwriting process with the insurance company and issue the policy before the donor makes the charitable gift. The ILIT trustee handles all of the transactions with the insurance company and is the legal owner of the policy. After the ILIT is funded and the policy has been issued, then the gift of appreciated property is made to the charity.

Example 2.3.2A Gift and Insurance Trust

James Johnson has an estate of $4 million and has served as a volunteer on his university's alumni committee for many years. The university is conducting a capital campaign and has asked James for a gift of $400,000. He owns an appreciated parcel of development land worth $400,000 and is considering giving that land to the university.

However, he is concerned that his nephews and nieces would not then receive the $400,000 as part of their inheritance. Fortunately, his tax advisor suggests that James replace the $400,000 through an irrevocable insurance trust.

James contacts his life underwriter and they work with his attorney to create an irrevocable trust. After his physical is completed, the trust acquires as owner a one-life variable universal life insurance policy with James as the insured, but not the owner. James then deeds the development land to the charity. Based upon a qualified appraisal, he receives a charitable deduction of $400,000. James spreads the tax savings from his charitable deduction over four years. James transfers this in tax savings each year for four years to the trust. Each of his four nephews and nieces holds a Crummey power that allows them respectively to withdraw one-fourth of the trust premium for a period of 30 days. After the 30 days passes, the power lapses and the funds may be used to acquire the insurance policy.

Since the irrevocable insurance trust is excluded from his estate and the life insurance will both increase in value and pay nontaxable proceeds to the nephews and nieces, James has created the "four-tax-benefit" plan. He bypasses the capital gain and receives an income tax deduction on the gift. The ILIT is free of both income and estate taxes. This plan allows James to make a major gift to the university's capital campaign and still provide a generous inheritance to nephews and nieces.

Related Topics on Gift and Insurance Trust

2.3.1  Gift of Appreciated Property:    For donors who own appreciated real property, a gift can maximize tax savings. The selected parcel of land may be transferred by deed to a charity. Normally, the charity then sells the real property. The donor bypasses gain on the gift and uses the charitable income tax savings to offset other taxable income.

Crummey:    In Crummey v. Commr., No. 21,607 (9th Cir. 25 June 1968), Dr. Clifford Crummey created an irrevocable trust for the benefit of his four children. He and his wife funded the trust each year with cash transfers. Their four children each held a power, exercisable until December 31 in the year of the transfer, to withdraw an amount up to $4,000, or the amount contributed to the trust, whichever was less.

Cristofani:    In Estate of Cristofani v. Commr., 97 T.C. 74 (29 July 1991), decedent Maria Cristofani had created an irrevocable life insurance trust. The trust directly benefited two children, but five minor grandchildren held contingent remainder interests. The trust included a "Crummey" power for each of the two children and for the five grandchildren.

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