Irrevocable Trusts are often created to own life insurance policies. The significant advantage is that the death proceeds are not included in the insured’s taxable estate upon his death. Further, the death proceeds are not taxable in the surviving spouse’s estate, even though she has access to the proceeds to maintain her lifestyle. Upon the second death, the proceeds pass tax free to the children or beneficiaries of the insured’s choice. Consider this example: Dad and Mom have a taxable estate. They need life insurance in the event Dad prematurely dies. He purchases a $2 million policy. Upon the second death of Dad and Mom, if Dad owns the policy the children may receive only $1 million because of federal and state estate taxes. If Dad’s Irrevocable Trust is the owner and beneficiary of the policy, upon his death the proceeds are available for Mom, and at Mom’s death pass to the children estate tax free.
To achieve the desired estate tax benefit, premiums must be paid by the Trustee on behalf of the Trust as the policy owner. When Dad writes a check for the premium, the check is written to the Trustee, not directly to the insurance carrier. This premium payment constitutes a gift to the children because the children are Trust beneficiaries.
Now it gets complicated: In order to use Dad and Mom’s annual exclusion ($12,000 each per child), the gift must be a “present interest.” If the payments are made to a Trust, however, in which the kids do not receive benefits until Dad and Mom die, the transfer is not a present interest. Thanks to Mr. Crummey (yes, that is his name), a taxpayer who came up with this plan, Dad and Mom can send out a “Crummey” letter converting the premium payment into a present interest by giving the children (or guardians if minor children) the right to withdraw the premium payments. Consider this example: Dad’s premium is $48,000. He sends a check to his brother Bill, who serves as the Trustee. Bill deposits the $48,000 in Dad’s Irrevocable Trust Account. Upon receipt of the funds, Bill sends a letter to Dad’s two adult children, telling them “as beneficiaries you have 30 days to withdraw your share, which equals $24,000.” After 30 days, Bill sends a Trust check for the premium payment to Large Insurance Company.
The end result is Dad and Mom use their annual exclusions for the premium payment, saving $48,000 of their exemption, and the Trust protects the death benefit for Mom and ultimately the children estate tax free. There may be additional issues, such as is the $48,000 coming all from Dad’s account, which is allowed as long as Dad and Mom “gift-split”; or do they each write checks out of their own accounts for $24,000; or does it come out of a joint account – all of which are options but require subtle distinctions to make it work. These latter gifting issues are the subject of a future Post.