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Home » Can a Beneficiary Also Be the Trustee of an ILIT?

Can a Beneficiary Also Be the Trustee of an ILIT?

February 11, 2021Trust in Indianapolis

  • Indianapolis trust attorneys

A comprehensive estate plan can help you accomplish various goals; however, to do so you will likely need to make use of several different estate planning tools. Trusts, for example, are commonly found throughout the average estate plan. Trusts have evolved to the point where there are a variety of highly specialized trusts that serve very specific purposes. One such trust is an irrevocable life insurance trust, or ILIT. The Indianapolis trust attorneys at Frank & Kraft explain why you might not want a beneficiary of your ILIT to also be the Trustee.

How Does a Trust Work?

A trust is a fiduciary legal arrangement that allows a third party, referred to as a Trustee, to hold assets on behalf of a beneficiary or beneficiaries. The person who creates a trust is referred to as the “Settlor”, “Trustor” or “Grantor.” The Settlor transfers property to a Trustee, appointed by the Settlor. The Trustee holds that property for the trust’s beneficiaries as well as invests trust assets and administers the trust terms according to the terms created by the Settlor. Trusts all fall into one of two categories – testamentary or living trusts. A testamentary trust is activated by a provision in the Settlor’s Will at the time of death whereas a living trust activates once all formalities of creation are in place and the trust is funded. Living trusts can be further divided into revocable and irrevocable living trusts. Because a testamentary trust is activated by a provision in the Settlor’s Will, and a Will can always be revoked up to the time of the Testator’s death, a testamentary trust is also revocable up to that point.

What Is an Irrevocable Life Insurance Trust?

An Irrevocable Life Insurance Trust is a highly specialized trust that provides tax advantages along with the general benefits you get from a trust. Life insurance proceeds usually pass to the named beneficiary free of any income tax; however, the payout from a life insurance policy is generally included in the “gross estate” of the policy owner for estate tax purposes at the policy owner’s death and is potentially subject to federal and state estate taxes. At a tax rate of 40 percent, gift and estate taxes should be avoided whenever possible. An ILIT takes advantage of a loophole created by Congress. If an ILIT is created to own the life insurance policy and the proceeds of the life insurance policy are payable to the trustee of the ILIT upon the insured’s death, then the proceeds are not included in the insured’s estate and, therefore, are not taxable for federal estate tax purposes. This applies even though the insured gives the money to the Trustee of the ILIT to pay the annual premiums of the life insurance policy. 

Can a Beneficiary Be the Trustee of an ILIT?

From a legal perspective, there is no impediment to a beneficiary of an ILIT also being the Trustee of the trust. The better question, however, is whether you should appoint a beneficiary as your Trustee. The Trustee of a trust has many duties and responsibilities; however, in general, a Trustee is responsible for managing trust assets and administering the trust using the terms created by the Settlor. Most professionals advise against appointing a beneficiary as the Trustee, particularly if there are additional beneficiaries as well. The likelihood of a conflict arising increases exponentially under such circumstances. By the same token, the Settlor cannot be the Trustee because that results in the Settlor having an incident of ownership in the life insurance policy which, in turn, means that the policy proceeds would be taxed in the estate of the Settlor upon his or her death. Given both the complex nature of an ILIT, and the important part one often plays in an estate plan, it is wise to consider appointing a professional Trustee if you choose to include an ILIT in your overall plan.

Contact Indianapolis Trust Attorneys

For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about an ILIT trust, contact the experienced Indianapolis trust attorneys at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.

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Paul A. Kraft, Estate Planning Attorney
Paul A. Kraft, Estate Planning Attorney
Paul Kraft is Co-Founder and the senior Principal of Frank & Kraft, one of the leading law firms in Indiana in the area of estate planning as well as business and tax planning.

Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
Paul A. Kraft, Estate Planning Attorney
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To ensure that your estate doesn’t lose assets to federal gift and estate taxes you may need to include tax avoidance strategies in your estate plan. One estate planning tool that can provide tax avoidance benefits is a Grantor Retained Income Trust, or GRIT. Always consult with your estate planning attorney before deciding what tools to incorporate into your estate plan. In the meantime, however, the Indianapolis trust attorneys at Frank & Kraft explain how a Grantor Retained Income Trust works and why you might want to include one in your estate plan. What Is a GRIT? A GRIT is a specialized type of irrevocable trust that allows the Grantor (creator of the trust, also referred to as the “Settlor”) to transfer assets into the trust while retaining the right to receive all of the net income from the trust assets for a fixed term of years, referred to as the “initial term.” Income from the trust is distributed to the Grantor at least annually during the initial term. At the end of the initial term, the remaining principal is either distributed to the trust beneficiaries or remains in the trust for the benefit of those beneficiaries. The primary benefit of a GRIT is that if (this condition is important) the Grantor survives the initial term, the value of the principal held in the GRIT is excluded from the Grantor’s estate for federal gift and estate tax purposes. How Does a GRIT Help with Tax Avoidance? The tax avoidance benefit of a GRIT is found in how the value of the trust principal is determined because those assets are valued at a discount. The value of the discount depends on the length of the initial term of the GRIT, and the applicable federal rate in effect at the time the GRIT is established. The transfer of assets to a GRIT constitutes a gift equal to the total value of the assets transferred to the GRIT, less the present value of the retained income interest held by the Grantor for the initial term. If the Grantor survives the initial term, the assets comprising the GRIT will pass to the designated remainder beneficiaries at a reduced gift tax value. GRIT Beneficiaries Section 2702 of the Internal Revenue Code determines who you cannot name as a beneficiary in a GRIT. Excluded beneficiaries include your spouse, your ancestors or the ancestors of your spouse, any lineal descendant of yours or your spouse, any sibling of yours or your spouse, or the spouses of any of the foregoing persons. You can name lineal descendants of siblings, (nieces and nephews) relatives even more distant than nieces and nephews, or friends of yours or your spouse as beneficiaries of a GRIT. How a GRIT Works in Practice Imagine that you establish a 15-year GRIT and transfer $100,000 of assets into the trust and that the applicable federal rate is five percent. As the Grantor, you will receive the income from the GRIT during the initial term. The present value of the retained income interest is $66,007, making the value of the gift $33,993. If you survive until the end of the initial term, however, the remainder beneficiaries will receive $100,0000 plus all capital growth. Your estate, however, will only need to acknowledge a lifetime gift in the amount of $33,993 (the applicable value of the gift at the time it was made). Disadvantages of Using a GRIT Just like most tax savings tools and strategies, there are some disadvantages to relying on a GRIT. First, it is an irrevocable trust, meaning if your personal circumstances change, you cannot make corresponding changes to the trust. Second, if you do not survive the initial term the advantages gained by creating a GRIT do not apply. Contact the Indianapolis Trust Attorneys For more information, please download our FREE estate planning worksheet. If you have additional questions or concerns about establishing a Grantor Retained Income Trust, contact the experienced Indianapolis trust attorneys at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.
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