Cash Values in Life Insurance Policies and Irrevocable Trusts

Some of you may have adopted an irrevocable life insurance trust (“ILIT”) as a part of your estate plan, or own life insurance policies outright, with a cash surrender value. The principal motivation for many people using an ILIT is to insure the proceeds of the life insurance policy are outside the decedent’s estate and/or the estate of the insured’s spouse. In most cases, insurance proceeds will usually be free of income taxes as well. You may have purchased the life insurance as a means of providing the cash to pay anticipated estate taxes.

However, estate taxes don’t affect everyone. In fact, the exemption from federal estate taxes has increased significantly since 1997, while the estate tax rate has significantly decreased. For example, in 1997, the lifetime gift and estate tax exclusion was $600,000 with a taxable rate of 55% for amounts over the exclusion in the Decedent’s estate; in 2017, the exemption is $5,490,000 with a rate of 40%.

So what should you do with your ILIT or life insurance policy if your estate will be well below the current exemption amount or the original estate plan is no longer needed?

Sometimes selling or cashing out the policy makes sense, especially when rising premiums are a financial struggle or other needs arise, as noted in this recent New York Times article entitled “Wringing Cash From Life Insurance:” https://nyti.ms/2z5xTWi.

This includes compelling distributions of cash from an “irrevocable” trust. Where proper grounds are set forth and proved, a court of equity may set a trust aside or decree its termination. Thus, if the trust settlor (i.e., creator) and all beneficiaries consent to termination of an ILIT and none of them is incapacitated, Colorado and numerous other states allow the interested parties to terminate the ILIT and distribute the cash therein sooner than was contemplated, even though the purposes of the trust have not been accomplished and the trust agreement specifically provides that the trust shall be irrevocable.

Because of the various issues and options, and potential tax consequences, we strongly recommend first consulting with your accountant or financial advisor before choosing to terminate any trust, whether revocable or irrevocable, or before letting a life insurance policy lapse. Once you have consulted with your professional advisors, you should obtain appropriate legal advice from an experienced trust and estate attorney to ensure your estate plan goals are being met now and into the future.

By: Jonathan Leinheardt