IRREVOCABLE INSURANCE TRUST
GENERAL EXPLANATION OF ADVANTAGES AND DISADVANTAGES
The trust is irrevocable. Once a policy is transferred to it, the trust cannot thereafter be changed. If, and only if, you survive for three years after transferring the policy to the trust will the insurance proceeds not be taxed in your estate or your spouse's estate. The resulting death tax savings can be very substantial. It is, therefore, very important for you and/or your broker to have the policy transferred to the trust as soon as possible. If you have not yet made application for the policy, then it would be best if the policy was, in fact, purchased directly by the trust rather than purchased by you and then transferred to the trust. It is possible that we can avoid the "three year wait" if this procedure is followed.
Each time a premium payment is made through the trust, the trustees need to send certain notification letters to each of the beneficiaries, including any minors. We will be happy to take care of this for you if you will advise us when the premium payments are being made and how much each payment is. However, if you wish to handle the notification letters yourself, we are enclosing a copy of our standard notification letter, as well as the notification to guardian letter if this is applicable. These forms can be used by the trustees themselves if they wish to do so.
The notification letters also need to be sent to each beneficiary when the policy is transferred to the trust.
With respect to the premium payment procedure, it is best if you pay the premium amount to your trustees who will then deposit it to the trust's bank account. This payment should be made as soon as the premium bill comes in. The trustees will then send out the notification letters and, on the due date of the premium, they should pay the premium from the trust's checking account to the insurance company.
Sending the notification letters to the beneficiaries is very important from a gift tax standpoint. The $11,000 per donee gift tax exclusion applies only if these notification letters are properly sent each time a premium contribution is made to the trust, or a policy is transferred into the trust. Your trustees should keep a file containing all of the notification letters in them.
When you and your insurance broker transfer the insurance policy to the trust, please be sure that you use the appropriate forms. The transfer must be made on an "Irrevocable Assignment" basis. In other words, the trust should be named as the new "owner" of the policy, as well as the new beneficiary. It is not sufficient to merely designate this trust as the beneficiary.
Sending the notification letters to the beneficiaries is very important from a gift tax standpoint. The $11,000 per donee gift tax exclusion applies only if these notification letters are properly sent each time a premium contribution is made to the trust, or a policy is transferred into the trust. Your trustees should keep a file containing all of the notification letters in it.
Finally, the transfer of the policies to the trust (and perhaps the annual premium payments) may require the filing of a gift tax return. To reduce the value of the policy to a lesser level to avoid or reduce the gift tax consequences, you may want to borrow against the policy before transferring it to the trust. Even if a gift tax return is not required, you may wish to file one anyway in order to make important generation skipping transfer tax elections. Generally, any such generation skipping transfer tax elections with respect to a term policy are deferred until you die, but with respect to a whole life policy or a policy for which there is a whole life component, it is desirable to make the generation skipping transfer tax elections now.
SETTING UP A TRUST
The first steps an insured must take to implement the Trust includes meeting with an insurance agent and attorneys or other professionals to determine which policies should be placed in the trust. The insured's attorney will have prepared the trust agreement which names the trustee, the "Crummey" beneficiaries, the time period for the withdraw right and the holder of any special powers. When the final document has been approved, the insured and the trustee sign the trust agreement and each keeps a copy. The insured provides the trustee with names and addresses for the "Crummey" beneficiaries named in the trust.
In most cases, new policies are issued to fund the trust and the trustee is named as both initial owner and beneficiary. If the insured has existing policies which are to be transferred (as gifts) to the trust, then he must file absolute (i.e., irrevocable) assignment forms with the insurance company which designate the trustee as owner and beneficiary. The life underwriter generally assumes responsibility in this situation. After the assignments have been accepted by the insurance company, copies should be provided to both the insured and the trustee.
It is recommended that the trustee keep the original insurance policies and endorsements with his or her important papers. Copies can be provided for the insured. The insurance company should be instructed to send all notices of premium payments directly to the trustee, with a copy to the insured.
At this point, the initial steps to transfer the policies have been taken, the trustee has a signed copy of the trust document and has been provided with the addresses of the "Crummey" beneficiaries. There are a number of things which must be done at this time:
The "Crummey" beneficiaries must be given notice of the new trust and their rights under the trust. This letter should be sent immediately after the insurance policies are purchased (this is when the first premium is paid to the trustee) or assigned to the trust by the insured. The trustee should send a photocopy of all letters to the insured and keep a copy for his/her records. If existing policies are assigned to the trust, the "Crummey" beneficiaries will have a right to withdraw from the cash value of the policies.
Open a bank account for the trust. The trustee must write checks to pay the insurance premiums so a checking account is required. In most cases, the premium deposits will be in this account for only a few weeks, so a noninterest-bearing account will simplify tax matters. There will then be no interest income to require the filing of an income tax return for the trust. The account should be titled "[name of Trustee], Trustee for the [name of Settlor] Trust Agreement dated [date trust signed]".
The insurance companies and the bank will require a Federal Tax Identification Number (TIN) for the trust. We will provide a TIN number for the trust.
If new insurance policies are being purchased for the trust, the insured will deliver a check for the initial premium to the trustee. The trustee immediately deposits this check in the trust's bank account and sends notice of this contribution to each of the "Crummey" beneficiaries. Further discussion of the contents of this letter notice and a sample form will be found later under Maintenance of the Trust, paragraph 3.
Obtain IRS Form 712, Life Insurance Statement, for each existing policy which is assigned to the trust. The insurance company will provide this. The statement provides the net value of the policy for gift or estate tax purposes. If the value of policies given to the trust in any one year exceeds $11,000.00 times the number of "Crummey" beneficiaries, then a federal gift tax return must be filed. This is not necessary for new policies. Although not required to do so, a gift tax return may be advisable to toll the statute of limitations or to make certain generation skipping transfer tax elections.
The trustee should maintain a ledger card to record receipts of premium deposits and payments of insurance premiums or interest.
The trustee should establish and maintain a permanent file to preserve important trust documents. The suggested items to be placed in the file include:
A signed copy of the Trust Agreement;
Assignments of insurance policies to the trustee and IRS Form 712 (only for old policies transferred to the trust);
Names and addresses of "Crummey" beneficiaries;
Federal Employer Identification Number (if required); and
Copies of all notice letters sent to "Crummey" beneficiaries.
MAINTENANCE OF THE TRUST
Trust maintenance consists of collecting premium deposits, paying the insurance premiums, and mailing notices of right of withdrawal to the "Crummey" beneficiaries. There will be additional duties if the designated individual exercises the Special Power of Appointment. Other decisions or policy transactions can result in additional responsibilities. For example, if the policy premiums are "vanished" after a number of years, paid up additions may need to be surrendered in subsequent years.
Once the Trust has been established, the trustee's duties will include the following:
Collect Premiums. The insurance company will send the premium notice to the trustee as owner of the policy. The trustee must immediately forward a copy of the notice to the insured with a request that the insured forward funds to pay the premium and/or interest due to the trustee. The trustee should keep a copy for his/her records. The insured's payment must reach the trustee in time to allow for passage of the withdrawal period before the trustee pays the premium before the due date to the insurance company. Two things are important. First, the insured, with the help of his or her insurance advisor, determines the amount to be paid. He may pay the full premium, interest only, or there may be no payment at all if the premium is to be borrowed from a loan under the policy. If the insured is not making a payment, he should notify the trustee what is to happen so the trustee will know the policy will not lapse without the payment. Second, the insured must consider that the trustee must hold the premium funds for the withdrawal period before the premium are paid C the funds must be received early enough to avoid lapsing of the policy.
The insured sends funds to pay the premium and/or interest due on the policy to the trustee. A few extra dollars should be included to cover any charges for the trust bank account. The insured's check should be payable to "[name of trustee], Trustee". It is again emphasized that the insured must send the funds to the trustee so the withdrawal period can expire before the trustee pays the premium to the insurance company. One way to take care of this is to enlist the cooperation of an insurance agent. The agent can give the insured annual notice that the premium is coming due and can do this far enough in advance to ensure a timely deposit. He or she will also have records to remind the insured of the amount due. In some cases it may be difficult or impossible to collect the premiums and allow the required notice period to pass. Some methods to deal with this situation are discussed below.
Deposits. Immediately upon receipt, the trustee must deposit the insured's contribution to the trust's bank account. The deposit is entered in the ledger page for the trust as a receipt from the insured.
"Crummey" Beneficiary Notices. The Trust Agreement gives the beneficiaries the opportunity to send the trustee a request to withdraw a proportionate share of each contribution made to the trust by the insured. This applies only to contributions and would not, for example, apply to dividends received from the insurance company or to premiums paid by surrendering of additions after the premium has "vanished". This right to withdraw lasts for a time period specified by the trust agreement (usually 30 days). So, upon receipt of each contribution to the trust from the insured, the trustee must promptly notify each "Crummey" beneficiary that a deposit has been made with the right to withdraw. This is done by sending a letter to each beneficiary stating the amount that has been contributed to the trust, the period during which the request for withdrawal must be made, instructions for determining the amount subject to withdrawal, and how the trustee is to be notified if a withdrawal is requested. Copies of this letter should be sent to the insured for his or her permanent records and the trustee should also retain a copy. In the case of a minor beneficiary, notice should be sent to the non-insured parent or guardian of the minor. The 30-day withdrawal period begins to run when the notice letters are mailed. The insurance premiums should not be paid until the 30-day withdrawal period has passed. So we again emphasize that the trustee must act promptly to collect the premium and send the notification letters.
As stated previously, the premium cannot be paid until the withdrawal period has terminated. There are exceptions to every rule, including this one. A time may come when the check is delayed in the mail or the insured is on vacation when the premium comes due. The trustee's first priority is to pay the premium on time, even if the withdrawal period is not complete. Most policies provide limited grace period to pay the premium, but you must never exceed this. It is the insured's responsibility to get the premium to the trustee with time for the withdrawal period to pass. If he/she fails to do this, then the trustee must pay the premium on time and let the insured deal with any adverse tax consequences that may arise from a shortened withdrawal period.
There is one way to avoid the problem of late premium deposits which do not permit a proper withdrawal period. First, while there is no authority directly on point, it would appear that as long as there are cash values in the policies sufficient to satisfy or pay any potential withdrawal request, then a cash equivalent is available to the trustee to pay the withdrawal request and the technique will remain viable.
"Crummey" Beneficiary Requests For Withdrawal. In the event that a "Crummey" beneficiary requests a withdrawal from the trust, the trustee must send the amount requested (up to the maximum permitted by the Trust Agreement) to the requesting beneficiary. Only beneficiaries who send written requests during the withdrawal period are permitted to withdraw from the trust. All requests for withdrawals should immediately be reported to the insured. The insured will want to be certain that the requesting beneficiary understands the purpose of the trust. If the withdrawal request is not withdrawn by the beneficiary, then the amount requested, up to the limit specified by the trust, must be sent to the requesting beneficiary. This amount will generally be a portion of the insured's contribution to the trust. Now the funds in the trust probably will be insufficient to pay the premium due on the insurance policy. (This is why "Crummey" beneficiaries should not request withdrawals from premium deposits to the trust -- they jeopardize their interest in the death benefits if the policy lapses). In such a case the insured may have to make another contribution to the trust to replace the withdrawal. New notice letters must be sent to the "Crummey" beneficiaries for any additional deposit by the insured. If it appears that the beneficiary will again request a withdrawal, the insured may wish to exercise his or her power to designate the gift "recipients" under the trust and exclude this beneficiary.
Pay Premiums. Following the passage of the withdrawal period, the trustee writes a check on the trust bank account to the life insurance company to pay the premium or interest due on the policy. The trustee should keep a copy of the premium notice for the trust's records and mark the copy of the premium notice with the date and check number of the payment. Retaining the canceled check in the file is also helpful. The trustee sends the premium check and premium notice to the insurance company. The trustee must wait for the withdrawal period to pass before paying the premium unless arrangements have been made as discussed in number three, above.
***Premiums must be paid before the end of the grace period to ensurethat the policy does not lapse.***
Bookkeeping. The trustee enters the premium or interest payment in the ledger page as a withdrawal from the trust, balances the trust checking account, and verifies that the balance in the bank account agrees with the ledger page.
This is the procedure which the trustee must follow for each premium on life insurance policies held by the trust. In the event that the insured has multiple policies in the trust, he may elect to make one or two deposits to the trust during the year to pay all premiums. If the insured wants to make one large deposit to cover several policy premiums, his insurance agent should be able to estimate the total required to cover the premiums or interest. A reminder, the trustee should send notices to the "Crummey" beneficiaries for each deposit made by the insured. The first gift to the trust in each year should be at least $5,000 per "Crummey" beneficiary, or if less, the full annual premium.
The following items are instructions for special situations which may occur.
INTEREST AND DIVIDENDS. If the insured has borrowed on any policy held by the trust, there will be interest payments due on the loan. Interest bills should be treated in the same manner as premiums. The insured will deposit the interest amount due with the trustee. The trustee notifies the "Crummey" beneficiaries of the deposit of interest or premiums and then pays the interest or premium as directed by the insured. If the insured does not know what to pay, he should contact his agent.
A whole life policy earns dividends after the first year. In many cases the dividends will be credited to the premium, reducing the amount which will be due from the insured. Dividends which reduce policy premiums are not considered deposits by the insured and there is no requirement to send notices to "Crummey" beneficiaries.
With some older policies, the dividend may be greater than the premium amount. Depending on the dividend option, the excess dividend may then be paid to the trustee by the insurance company. If so, the trustee will deposit the dividend to the trust bank account. Since the dividend is paid by the insurance company and not the insured, there is no requirement to send notices to the "Crummey" beneficiaries. Dividends which have been deposited to the trust account may be used to pay premiums or interest on the insured's other policies. If there are no other policies, then the dividends will accumulate in the trust's bank account.
POLICY LOANS. Most whole life insurance policies accumulate a cash value as they get older. The policy and trust provisions will generally permit the person appointed by the insured to borrow from this cash value. The trust agreement should designate an individual who is authorized to instruct the trustee to borrow from the policy. This designated individual is the holder of a Special Power of Appointment. The holder is not the insured or the trustee. To borrow from the policy cash value, the individual holder of the Power will send a signed and dated request to borrow to the trustee specifying the amount to be borrowed and the policy to be borrowed from if there is more than one. The holder of the Power may also designate how the trustee is to disburse the borrowed funds.
All actions by the holder are subject to the terms of the Trust Agreement. When the trustee receives instructions to borrow, he/she should consult the Trust Agreement to be certain that the person requesting the loan is authorized; that the amount is proper; and that disbursement is requested to persons authorized to be recipients.
Upon receipt of these instructions, the trustee must ask the insurance company for forms and instructions to borrow from the policy. The trustee will complete the loan forms and return them to the insurance company. The company issues its check for the requested amount payable to the trustee and the trustee deposits this check to the trust bank account.
Notices are not required to be sent to the "Crummey" beneficiaries for this deposit. When the insurance company's check has cleared, the trustee can then issue a trust check for the amount of the loan proceeds payable to the trust beneficiaries. The trustee should keep copies of all loan documents and requests in his files and record the transaction in the trust ledger page.
Future premium notices for this policy will include interest payments for the amount borrowed. The trustee will collect the funds to pay interest from the insured in the same manner as premiums are collected. The insurance company or agent can provide an estimate of the interest amount which will be payable each year so the insured can be certain to deposit sufficient funds to cover both the interest and premium due on each policy in the trust. The "Crummey" beneficiaries have a right to withdraw from all payments the insured makes to the trust, whether for premium or interest. So the trustee is required to send notices to the "Crummey" beneficiaries for deposits to pay interest and otherwise treat them in the same manner as premium deposits.
SPECIAL POWER OF APPOINTMENT. As mentioned earlier, the Trust Agreement may give a designated individual the right to appoint trust assets to certain beneficiaries (who need not be the same as the "Crummey" beneficiaries). Since the trust assets are policies of insurance, the policies or their cash values may be subject to these distributions. Therefore, the designated individual may borrow from the cash value of the policy in order to make a distribution or to distribute the entire policy. In either case, the designated individual should send a signed and dated letter to the trustee to exercise this right. Upon receipt of such a request, the trustee should follow the procedure for policy loans or assignments as described above.
TAXES. The Trust is designed so that the trust will not have any income tax consequences in and of itself. Because the trust does not generate any income, it will not be required to file tax returns or pay taxes. It is suggested the trustee use a noninterest checking account for the trust to avoid income (the interest would be minimal in any event). So in most cases the trustee will not be required to file any tax returns for the trust that has been described.
There would be an exception to this if the trustee has used a checking account which pays interest. In that event, a fiduciary income tax return, IRS Form 1041 and the equivalent state return, may have to be filed by the trust. A consultation with a tax advisor may be in order if there are further questions.
If the trust does not file a return, the trustee may receive a notice from the IRS requesting information about the IRS Form 1041 which was not filed. Since the trust is not required to file this return if there is no income, the form should be completed and, in the remarks section, include: "No return is required because this trust is not a tax-paying entity pursuant to IRC 671."
END OF YEAR TRUSTEE SERVICES
In December of each year, the trustee must bring his records up to date and send a report of trust activities to the insured. The steps are to:
Balance trust account ledger page. Notify insured of any balance remaining in the trust account which may be used for next year's payments.
Balance trust check book. This balance should agree with the balance on the ledger page after adjustment for checking account fees.
Send a copy of all life insurance premium, interest or dividend notices to the insured. Indicate on each form the amount which has been paid. The insured can use these figures to determine the amount of deposit which will be required to pay the interest or premiums on the policies in the coming year. It is a good idea to send the insured a copy of the trust ledger page as a record of the status of the account.
If the trustee is charging for services, send a bill to the insured for next year's services.
In the permanent file which you are keeping, place the following items: Copies of notice letters sent to "Crummey" beneficiaries. Copies of insurance premium notices. The trust ledger page. Copies of any tax returns. Copies of other correspondence.
Taxes. Generally, there will be no tax returns to file or taxes to pay by the trustee. If there are any questions, contact your local tax advisor.
Other. The trustee will periodically receive correspondence from the insurance company with information on the status of the policy or offers to modify various policy features. These can be forwarded to the insured for his or her input or suggestions, but it is up to the trustee to make the decision as to what, if any, action to take.
Some of the terms which are used in this discussion are :
INSURED. The life insurance policies which are assigned to the trust (or purchased by the trust) insure the life of the "insured". The insured is the individual whose life is protected by the policies of insurance which have been placed in the trust. The insured may also be the settlor or grantor of the trust.
SETTLOR/GRANTOR. The settlor is the person who is establishing or setting up this life insurance trust. In many cases the settlor will also be the insured under the policies.
TRUSTEE. The Trustee is the individual or organization which is designated in the trust agreement to own the life insurance policies in trust and carry out the terms of the trust agreement. Generally, the sole asset of the trust will be insurance policies on the life of the insured. It is most important that the trustee faithfully perform his or her duties in order to ensure that the policies are kept in-force so the death benefits will be available to supplement the estate of the insured at the time of his or her death.
"CRUMMEY" BENEFICIARIES. Anyone who is entitled to receive benefits from the trust is a beneficiary. The "Crummey" beneficiaries are those individuals who are entitled to benefits during the years in which premiums are paid to the trust during the lifetime of the insured. The name "Crummey" comes from a court case known as Crummey v. Commissioner of IRS, which confirms the gift tax savings and advantages available to this type of life insurance trust. In this discussion, all references to beneficiaries will be to "Crummey" beneficiaries unless otherwise noted. The insured should provide the names and addresses of the "Crummey" beneficiaries to the Trustee. Any notice that needs to be sent to a minor may be sent to the child's parent who is not the insured. These letters should be sent certified mail and the return card should be kept in the Trust files.
Standard Notice Letter
Under your ___________________'s Trust Agreement dated ______________________, you have been granted the right to withdraw up to ____________ of the amount of any contribution made to the trust. In order to exercise this right, you must send me, as the agent for the Trustee, a written notice of the amount which you intend to withdraw. I must receive this notification with 30 days of the date of your receipt of this letter or 30 days after the date that the contribution is received by the trust, whichever is later. If I hear nothing from you, the Trustee will assume that you do not wish to make a withdrawal.
Notwithstanding the foregoing, certain rights of withdrawal may not terminate within the aforementioned 30-day period. A copy of the withdrawal right provision in the trust (Article ________________) is available upon request. In addition, certain beneficiary's rights to withdraw amounts from the trust may be cumulative and not terminate and otherwise not subject to the 30-day provision.
Your ______________ has made or anticipates making a $_________ contribution to the trust. Accordingly, your withdrawable ___________ share is $_________.
If the Trustee hears nothing from you, he will assume that you do not wish to make a withdrawal. However, I, as the attorney for the trust, would ask that you sign and return the enclosed copy of this letter to me to indicate your receipt of it.
If you have any questions concerning your rights, please give me a call.
Andrew H. Dohan
Receipt of this letter is acknowledged. I do not wish to exercise my withdrawal right at this time. My signature below is merely an acknowledgment of receipt of this letter and not a release or waiver of any withdrawal right.
Letter to Parent/Guardian of Minor Beneficiary
We are enclosing a copy of a letter sent to _______________ today informing him/her of his/her withdrawal rights under _________________'s Irrevocable Insurance Trust dated ________________. You, as his/her guardian, can exercise his/her power of withdrawal if you so desire by following the instructions explained in his/her letter.
Notice Letter for Group Insurance Benefits
Under your ____________________'s Irrevocable Trust Agreement dated _____________, you have been granted the right to withdraw up to ______% of the amount of any contribution to this trust by the insured, ________________________________________. Premium payments are being made throughout the year by these parties on an every ______ week basis. The combined total premium being paid every ________ weeks is $____________.
Until further notice to you that the premium amount has changed, you are hereby given notice of the foregoing premium payments and of your right to withdraw up to the aforesaid _____% amount of each such payment. Withdrawal rights may be exercised within 30 days of the date of any such premium payments. In order to exercise this right, you must send us, as Trustee, a written notice of the amount or amounts which you intend to withdraw and which week or weeks to which the withdrawal right pertains. This written notification must be received by us within 30 days of the date of the payment to which is pertains.
If we hear nothing from you, we will assume that you do not wish to make a withdrawal. However, we would ask that you sign and return the enclosed copy of this letter to indicate your receipt of it.
If you have any questions concerning your rights, please call.
Receipt of this letter is acknowledged. I do not wish to exercise any withdrawal rights at this time. My signature below is merely an acknowledgment of receipt of this letter and not a release or waiver of any withdrawal right. I waive the right to receive notification of any and all future gifts.