An irrevocable life insurance trust is an estate planning tool commonly used
to prevent life insurance proceeds from being subject to estate tax at the death
of the insured. In today’s unpredictable legislative environment, use of
standard funding techniques for insurance trusts may have unknown and unintended
generation-skipping transfer (GST) tax consequences.
Absent legislation from Congress, the GST tax, like the estate tax, “shall
not apply to generation-skipping transfers after Dec. 31, 2009.” The GST tax is
scheduled to return Jan. 1, 2011. For grantors and trustees funding or
administering life insurance trusts during 2010 and beyond, the temporary
suspension of the GST tax regime raises significant questions regarding the best
and safest way to pay insurance premiums.
When premium levels permit, gifts from the grantor is a common method of
funding the necessary insurance premiums. If such gifts are subject to so-called
Crummey rights of withdrawal, they may qualify for the gift tax annual exclusion
and not be subject to gift tax. In this respect, 2010 is the same as previous
years. The significant difference that arises in 2010 is that because the GST
tax does not apply to generation-skipping transfers, including some transfers to
trusts, it therefore is not always clear if and how GST exemption can be
allocated to those transfers.
In that case, when 2011 arrives and the GST tax returns, the trust may
contain assets to which no GST tax exemption was allocated. A trust that was
intended to be wholly exempt from GST tax may now be only partially exempt
unless a late allocation of GST exemption is made on or after Jan. 1, 2011. A risk in waiting to make a late allocation is that the insured may
die in the interim.
This result is unclear, and regardless of the result under current law,
Congress may legislatively provide, clarify, or change the treatment of such
transfers during 2010. If congressional action is retroactive (and survives
constitutional challenge), it is possible that allocations may be made (or may
be automatic) as though the lapse in the estate and GST taxes had never
During this period of uncertainty, one solution is for the trustee to borrow
funds from the grantor or a third party to use to pay insurance premiums. If
legislation during 2010 reinstates the GST tax or otherwise clarifies these
issues for this year, the grantor can make gifts to the trust later in 2010 for
the trust to use to pay off the loan. If no legislation is passed during 2010, a
loan to the trust eliminates the concern about the trust's fully exempt status
for GST tax purposes for 2011 and beyond, and the grantor may make gifts to the
trust in 2011 for the trust to use to pay off the loan. To avoid gift
implications, any loan from the grantor or a family member must bear interest at
no less than the Applicable Federal Rate as announced by the IRS and in effect
at the time of the loan.
Although loans to fund life insurance premiums may be classified as a
“split-dollar arrangement,” loans described above should not cause concern as
long as the terms of the promissory note are respected and the trust has the
ability to pay the principal and interest when due.
Another possible solution is to skip paying premiums during 2010 by using a
portion of the policy’s existing cash value to maintain the policy, and then in
2011 to reinstitute the gift program. Life insurance advisors should be
consulted before making a decision of this nature.
If loans or policy values instead of gifts are used in 2010 to maintain the
insurance, attention should be given to other possible uses of the 2010 gift tax
For more information on this subject, please contact
any of the authors or any member of our Private Wealth Services or Fiduciary
Advisory Services groups. Please refer to the McGuireWoods
white paper for additional information regarding the impact of the estate
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