Section 1B: Benefits Of An Irrevocable Life Insurance Trust[Continued]

1B.7 INSULATE LIFE INSURANCE PROCEEDS FROM PROBATE AND SUCCESSIVE TAXATION AT MULTIPLE GENERATIONS

With proper planning, life insurance proceeds can benefit successive generations without being subject to probate and without being included in the gross estates of the spouse and other beneficiaries. The use of an ILIT to hold the life insurance proceeds will avoid the proceeds being subject to probate when the insured dies and/or when trust beneficiaries die. This means that the life insurance proceeds may not be subject to a surviving spouse’s elective share or be part of the decedent’s augmented estate, depending on state law. Also, the ILIT can avoid the imposition of death taxes on the trust property when the beneficiaries die. However, to avoid death taxes when a trust beneficiary dies, the practitioner must carefully draft the ILIT. Also, be careful that the spouse and other beneficiaries are not deemed to hold a retained interest (because of a taxable release of a Crummey withdrawal right). See, sections 4.2 and 4.6, below. Also be careful when drafting the ILIT that the spouse and beneficiaries do not hold any general powers of appointment over the trust assets, either as a beneficiary or as a trustee. See, Chapter 8, below.

If a spouse or beneficiary serves as a trustee or co-trustee, that person’s powers (as trustee) must be limited to ascertainable standards such as “health, education, support, and maintenance,” as permitted under Treas. Reg. §§25.2511-1(g)(2), 25.2514-1(c)(2), and 20.2041- 1(c)(2). Typically, a clause limiting the trustee’s ability to make distributions that can result in the trustee possessing a general power of appointment over the trust property is used to accomplish this purpose. A clause that prohibits a trustee from using the trust property to discharge his or her personal legal obligations (including the obligation of support) is typically referred to as an “Upjohn” clause, and is named after the case where the clause was used and discussed by the court. See, William John Upjohn v. United States, 72-2 U.S.T.C. ¶12,888 (W.D. Mich. 1972). See, Paragraph 7.1(C)(4) of Sample ILIT. See, Chapters 8 and 9, below.

Make sure that the grantor’s spouse or a beneficiary does not hold any powers as a beneficiary that constitute a general power of appointment, such as the beneficiary’s unrestricted right to remove and replace a trustee with a related or subordinate party (as defined in IRC section 672(c)). See, section 9.1 (a), below. See, Paragraph 6.21 of Sample ILIT, which is modeled after Priv. Letter Rul. 9303018 and which sets forth a comprehensive list of IRS-approved reasons for a trustee’s removal for “reasonable cause” by a beneficiary.

In 1995, the IRS reversed its position taken in Rev. Rul. 79-353, and held that a grantor’s reservation of an unqualified power to remove an existing trustee and appoint a replacement trustee who is not related or subordinate to the grantor (within the meaning of IRC section 672(c)) is not a reservation by the grantor of the trustee’s discretionary powers of distribution that might cause trust corpus to be included in the grantor’s estate under IRC sections 2036(a) and 2038(a)(1) (concerning retained interests or the ability to affect the beneficial enjoyment of gifted property) and IRC section 2511 (for gift tax purposes, as an incomplete gift). Rev. Rul. 95-58, 1995-2 C.B. 191. The holding of Rev. Rul. 95-58 is as follows: Rev. Rul. 77-182 concludes that a decedent’s power to appoint a successor corporate trustee only in the event of the resignation or removal by judicial process of the original trustee did not amount to a power to remove the original trustee that would have endowed the decedent with the trustee’s discretionary control over trust income….Rev. Rul. 79-353 and Rev. Rul. 81-51 are revoked. Rev. Rul. 77-182 is modified to hold that even if the decedent had possessed the power to remove the trustee and appoint an individual or corporate successor trustee that was not related or subordinate to the decedent (within the meaning of section 672(c)), the decedent would not have retained a trustee’s discretionary control over trust income. In Priv. Letter Ruls. 9746007, 9735025, and 9607008, the IRS extended its holding in Rev. Rul. 95-58 to beneficiaries who were given the unqualified power to remove an existing trustee and appoint a replacement trustee who is not related or subordinate to the beneficiaries (within the meaning of IRC section 672(c)).

If a beneficiary can appoint him or herself as trustee or as a co- trustee (unless the other co-trustee has a substantially adverse interest in the trust), the beneficiary will be treated as possessing the powers of the trustee, which may result in the beneficiary holding a general power of appointment. Treas. Reg. §20.2041-1(b)(1). See, section 8.1(d), below, concerning “substantial and adverse interest.” Depending on the powers and assets held by the removed trustee, this could mean that the removing party will hold a general power of appointment over the trust assets (or possibly an incident of owner- ship with regard to life insurance policies held by the trustee insuring the life of the removing party), which will result in the trust property being included in the removing party’s estate under IRC section 2041 (or IRC section 2042 with regard to any life insurance policies). If the beneficiary holds a general power of appointment, he or she will be the (new) transferor for GST purposes and any GST tax exemption previously allocated by the grantor will be wasted. Limiting a beneficiary’s right to remove a trustee for reasonable cause will obviate this problem and provide flexibility concerning the choice of the successor trustee. Limiting the trustee’s powers of invasion to an ascertainable standard relating to the beneficiaries’ health, education, support and maintenance will also resolve this issue. Do not give the spouse or other beneficiaries an annual withdrawal right in excess of the greater of $5,000 or 5 percent of the trust corpus (often referred to as a “5✕5” or “five-by-five” power) (or, if a hanging power (which is discussed in section 3.13, below) is granted to a beneficiary other than the grantor’s spouse, make sure the hanging power is limited to the annual gift tax exclusion amount under IRC section 2503(b) and lapses each calendar year within the five-by-five safe harbor rules). Otherwise, the lapse in excess of five-by-five, in conjunction with an income/principal interest in the trust, will constitute a retained interest in the spouse’s (or other beneficiaries’) share of the excess property, which will be included in the spouse’s (or other beneficiaries’) estate as a retained interest (following the release of a general power of appointment). IRC sections 2036(a) and 2041(a)(2). See, section 4.2, below. Furthermore, there may be gift tax consequences to a lapse in excess of five-by-five. See, section 3.11, below. See, Paragraphs 3.1(A)(1) and 3.2(D) of Sample ILIT.

Also be careful about the powers and rights the beneficiaries may have over any policies of insurance on their lives held by the ILIT trustee. An insured beneficiary should: (1) not be permitted to serve as trustee of the trust that holds the insurance on his or her life (unless a co-trustee is granted exclusive ownership rights and control over the policy); (2) not hold any incidents of ownership over the life insurance policy; and (3) not hold a power of appointment over the policy. IRC sections 2042 and 2041. See, sections 4.8, 4.10 and 14.4, below. See, Paragraph 7.1(C)(3) of Sample ILIT.

Depending on the type of policy that the ILIT owns, the ILIT can also accomplish income free investing for the benefit of the insured’s beneficiaries. See, Chapter 16, below for a general discussion of life insurance policies, and how certain policies can be structured to pay for life insurance premiums income tax free and can be used to purchase mutual fund type investments without having to pay any income tax on capital gains, dividends, or interest received on those investments. Thus, with the right policy and with good investments contained within the policy, an ILIT can become a financial fortress that protects future generations of the insured’s family.

1B.8 REDUCE INCOME TAXES

An ILIT can reduce income taxes—federal, state, and local, if the ILIT is a separate taxpayer and is administered in a jurisdiction that does not impose a state income tax on the trust itself, and the ILIT trustee is able to either accumulate income and/or sprinkle income among the grantor’s descendants, who are in lower income tax brackets. An ILIT can also be structured so that the grantor is responsible for paying all the income taxes on the trust’s income, dividends, and capital gains. See, section 2.7, below. This will eliminate the ILIT having to pay income taxes during the grantor’s life- time and will help “preserve” the ILIT income and corpus for the beneficiaries and increase the ILIT’s net cash flow while reducing the grantor’s taxable estate. The grantor’s payment of the ILIT’s income taxes is the equivalent of a tax-free gift to the beneficiaries. See, section 3.18, below.

1B.9 MAKE IT EASIER FOR THE INSURED’S ESTATE TO QUALIFY FOR SPECIAL TAX TREATMENT

By removing an existing life insurance policy from the insured- grantor’s gross estate, it may be easier for the insured’s estate to meet the percentage requirements necessary to obtain special tax treatment under IRC sections 303, 2032A, 2057, and 6166.

1B.10 LEVERAGE THE INSURED’S GST TAX EXEMPTION

Use of an ILIT as a generation-skipping trust, or so-called dynasty trust, is an extremely efficient technique to leverage the transferor’s GST tax exemption and applicable exclusion amounts.1 The dynasty trust can be established with no withdrawal rights being grant- ed. Although the grantor’s transfer of property to the ILIT will be that of a future interest and, therefore, will not qualify for the annual gift tax exclusion, and the grantor will have to allocate his or her gift tax applicable exclusion amount and GST tax exemption to the transfer, the result will be a guaranteed insulation of the transfer and subsequent proceeds from successive generational tax. If the ILIT is designed as a generation-skipping trust, the following steps must be undertaken:

  1. If the ILIT is not a “GST trust” as defined in IRC section 2632(c)(3)(B), the transferor’s GST tax exemption must be allocated on a timely filed U.S. Gift Tax Return (IRS Form 709). See, section 5.32, below.
  2. The ILIT must be drafted to avoid creating general powers of appointment in the beneficiaries so as to prevent inclusion in their gross estates. If trust property is included in a beneficiary’s estate, that beneficiary becomes the (new) transferor for GST purposes and the original transferor’s previously allocated GST tax exemption will be wasted. See, section 5.10, below.
  3. The ILIT must be drafted to avoid the possibility of a taxable release of a Crummey withdrawal right. This can be accomplished by limiting the annual noncumulative withdrawal right amount to the lesser of either the gift contribution amount or the $5,000 ✕ 5% amount specified in IRC section 2514(e). Alternatively, the grantor could not grant any Crummey withdrawal rights and instead use part of his or her applicable exclusion amount. Another approach, which is a bit more risky, is to use a hanging Crummey power. See, section 3.13, below. The risk of a power holder dying before the hanging power fully lapses may be the appropriate trade-off for the increased amount of annual gift tax exclusion provided to the grantor.
  4. The ILIT must be drafted to avoid creating an estate tax inclusion period (“ETIP”). See, section 5.17, below. An ETIP prevents a transferor from currently allocating his or her GST tax exemption until the close of the ETIP (when the ILIT’s value for GST-tax-exemption allocation purposes may be even greater than the value of the transferor’s cumulative gifts to the ILIT).
  5. The ILIT’s term should be for the maximum length of time permitted by the state’s rule against perpetuities. Alternatively, the ILIT could be established in a juris- diction that has abolished the rule against perpetuities and where the exercise of a non-general power of appointment will not result in the application of the “Delaware tax trap” under IRC sections 2041(a)(3) and 2514(d).2 Even if the grantor is not a resident of a state that has abolished the rule against perpetuities, the grantor can choose the governing law of that state, provided there is a sufficient “nexus” between the ILIT and that state, such as having a co-trustee who is located in that state. But note this caveat: Professor Ira Mark Bloom of Albany Law School argues that the states, in a blind race to facilitate the exploitation of the GST tax exemption by perpetual dynasty trusts, have overlooked important non-tax societal reasons for the rule against perpetuities, which serves to limit “dead hand control.” He asserts that, over time, the administration of such trusts is likely to become unwieldy and very costly, noting that the average grantor will have more than 100 descendants in 150 years, 2,500 beneficiaries in 250 years, and 45,000 beneficiaries in 350 years. Subject to the foregoing, typical provisions of a generation skipping trust can include:
  • Separate shares for each child (rather than a single “pot” trust). See, Alternate 1 to Paragraph 5.3 of Sample Second To Die ILIT in Appendix 2.
  • A lifetime income interest for the children.
  • Principal invasion for the children that is subject to an ascertainable standard.
  • A five-by-five annual withdrawal power held by each child.
  • An intervolves limited power of appointment in favor of the children, issue or their spouses (provided the exercise of the power does not create a “Delaware tax trap,” which is discussed in section 3.16, below).
  • A testamentary limited power of appointment by each child over his or her share (provided the exercise of the power does not create a “Delaware tax trap,” which is discussed in sections 3.16, 4.7, and 5.26, below).
  • An option to provide for a child’s surviving spouse (typically a life estate).
  • The child can be trustee or co-trustee (if trust provisions are properly and carefully drafted). See, Chapter 8, below.
  • Trustee removal provisions. See, section 11.9, below.
  • Change of situs provisions (for portability). See, section 11.6, below.
  • An independent trustee’s ability to make discretionary income and principal distributions. See, section 9.7, below.
  • A special powerholder or trust protector. See, section 11.1., below.

1B.11 CREATE LIQUIDITY FOR THE INSURED’S ESTATE

If the life insurance proceeds are needed to provide liquidity (i.e., cash) to the insured’s estate, the trustee can be authorized (but not be required) to buy assets from the insured’s estate or loan3 funds to the estate. See, section 10.25, below. The trustee can also be authorized (but not required) to loan money to the insured’s estate, spouse, and descendants. Loans from the ILIT will help preserve the estate’s assets since they will not have to be liquidated, subject to a “forced” sale, or be sold to an “outsider.” This is particularly important where the estate assets may not be readily marketable, such as a closely held business. The estate can use the sales proceeds (or loans) to pay the insured’s debts, death taxes, and estate administration expenses. The trustee must not be required to purchase estate assets or loan monies, otherwise such requirements may be tantamount to “proceeds being receivable by an executor” and, therefore, taxable in the insured’s gross estate. Treas. Reg. §20.2042-1(b). See, section 4.9, below. See, Paragraph 5.2 of Sample ILIT.

1B.12 CREATE WEALTH AND INCOME REPLACEMENT FOR THE INSURED’S ESTATE

Besides creating liquidity for the insured’s estate, an ILIT can be used to create “instant” wealth upon the death of the insured, and can also be used to replace wealth that is either consumed during the insured’s life or will be consumed upon the insured’s death by estate taxes, income taxes, and estate administration expenses.

It is estimated that Generation X, Generation Y, and the Millennium Kids (to wit, the children of the baby boomer generation) may not receive much of an inheritance. This is because of their parents living longer and consuming more wealth to pay for their retirement expenses, home equity loans, rising health care costs, nursing home expenses, etc.4 A way to ensure that a baby boomer’s heirs will receive an inheritance is for the boomer to establish an ILIT and fund it with a limited pay permanent life insurance product. See, Chapter 16, below. The premium payments should be structured so that the policy is paid in full before the insured-boomer needs Medicaid assistance. In most states, the ILIT and the life insurance policy will be exempt from the claims of creditors, including Medicaid (assuming all transfers to the ILIT by the insured are more than 60 months prior to applying for Medicaid assistance).

The ILIT can also be used to provide income for the insured’s family, such as the surviving spouse, minor or disabled children, or other family members who may have no means or ability to be self- supporting.

An ILIT can serve as a wealth replacement vehicle concerning charitable giving. Many donors desire to make lifetime or testamentary charitable gifts if they can be assured that their family’s overall wealth will not be diminished because of the charitable gift. An ILIT can serve to alleviate that concern. For example, a lifetime gift of appreciated assets (such a closely held C corporation stock) to an intervivos charitable remainder trust (“CRT”) will avoid capital gains tax being paid by the donor when the assets are sold by the CRT (which is tax exempt), and the CRT will pay the donor an annuity (or unitrust) amount. IRC section 664(c). The donor will also get an immediate income and gift tax deduction equal to the present value of the remain- der interest that will pass to the charity. IRC section 170(c)(2)(A). Because the CRT is tax exempt and pays no income or capital gains tax, the CRT will be able to sell the appreciated assets tax free. This will result in the full value of the assets being available to pay a larger annuity (or unitrust) amount to the donor (rather than had the donor sold the appreciated assets and paid the capital gains tax). This “larger” annuity (or unitrust) amount (i.e., the income and capital gains tax savings amount) and the amount of the income tax savings from the charitable income tax deduction taken when assets were contributed to the intervivos CRT can be used to fund an ILIT. The ILIT can then purchase life insurance equal to or greater than the value of the contributed assets, thereby replacing (or increasing) the value of the assets that were transferred to the CRT. In many instances, the family’s overall wealth will actually increase because the ILIT proceeds will be free of income tax and estate tax. See, section 14.11, below.

1B.13 PROVIDE PROFESSIONAL MANAGEMENT OF THE LIFE INSURANCE PROCEEDS

An ILIT provides a vehicle for the management of the insured’s life insurance policy and subsequent proceeds. The ILIT protects beneficiaries who are inexperienced in the management and investment of money. If a beneficiary is a minor or under some other disability that prevents the beneficiary from properly managing and investing the proceeds, the ILIT protects that beneficiary. In these situations, the ILIT can provide for proper management, investment, and conservation of the life insurance proceeds for the continued benefit of the beneficiaries. See, sections 11.10, 11.11, and 11.12, below. See, Paragraph 1.6 of Sample ILIT.

1B.14 PROVIDE CREDITOR AND DIVORCE PROTECTION TO THE BENEFICIARIES

An ILIT can also insure that the grantor’s beneficiaries are protected from their inabilities, disabilities, predators, and creditors, including potential ex-spouses (in some instances).5 An outright transfer of an insurance policy to beneficiaries cannot provide such protection nor provide the control that the grantor may desire. Maximum flexibility and creditor protection can be achieved through the use of a disinterested or independent trustee with broad discretionary powers over the trust, a spendthrift provision, and the non-insured surviving spouse having a testamentary limited power of appointment over the ILIT (after the death of the grantor-insured).6 Additionally, flexibility can be provided by allowing the trustee to permit a beneficiary to use trust assets, such as a house, free of rent, and by permitting the trustee to move trust assets to a less creditor-friendly jurisdiction by changing the situs of trust administration.7 See, section 14.2, below. See, Paragraphs 1.6, 4.1(A), 5.1(A)(2), 5.4(A) (alternate 2), 5.4(B) (alternate 2), 5.4(C) (alternate 2), 5.5(A), 7.1(A)(15), 7.2, 7.3, and 8.3(A) of Sample ILIT.

1B.15 PROVIDE INCENTIVES TO BENEFICIARIES

The ILIT can contain provisions that seek to affect a beneficiary’s behavior by conditioning a distribution from the ILIT on the beneficiary’s adoption (or rejection) of certain types of behavior or characteristics, or the beneficiary achieving certain goals deemed desirable by the grantor, provided the goals are not illegal or against public policy. The grantor can attempt to influence the beneficiary’s behavior by setting forth the grantor’s philosophy concerning who, when, how, and why the ILIT trustee is to make distributions, or the grantor can set forth explicit objective criteria in the ILIT for the trustee to follow.

1B.16 PROVIDE FLEXIBILITY IN AN UNCERTAIN AND CHANGING ENVIRONMENT

The use of certain trust provisions, along with an independent trustee, coupled with a special powerholder (or trust protector) can provide significant flexibility, thus enabling the ILIT to be “flexible” and to adapt to changing circumstances, if that is what the grantor desires. See, Chapter 11, below.

1B.17 PROVIDE/EQUALIZE INHERITANCE FOR CHILDREN WHO ARE NOT ACTIVE IN THE FAMILY OWNED BUSINESS

If the grantor owns a business where some of the children are active in that business and will eventually inherit the business from grantor, life insurance owned by an ILIT can be an inexpensive way to provide an inheritance for the inactive children, or to “equalize” the inheritance between the active and inactive children, so that the inactive children are treated fairly.8 For example, the ILIT can be for the sole benefit of the inactive children and their descendants. Or, the ILIT can provide for an adjustment (i.e., increase) of the inactive children’s beneficial share in the ILIT (after the grantor’s death) based on a formula tied to the value of the business inherited by the other children. The ILIT can also provide a source of liquidity to pay the death taxes attributable to the closely held business by making loans to the business or to the children who inherit the business. See, section 10.25, below. Leaving the business to the active children and life insurance to the inactive children not only equalizes the inheritances among the children but also avoids the need for the active children to purchase the interests of the inactive children—perhaps at a time when the business may be unable to afford it.

1B.18 CREATE A FAMILY BANK FOR THE ACTIVE AND INACTIVE CHILDREN IN THE FAMILY-OWNED BUSINESS

When the decision is made to leave the business to both active and inactive children, it is usually advisable to leave only the active children with voting interests in the business. In addition, “put” and “call” options-agreements should be entered into. Usually, a put option requires the business to purchase all or a portion of the inactive children’s interest in the business upon a set price and terms. Without a put option, there may be no practical way for an inactive child to benefit from owning the business interest unless the business is sold.

On the other hand, a call option allows the active children (or the business itself) to purchase the business interests of the inactive children upon a set price and terms. Without a call option, there may be no effective way for the active children to avoid conflicts that can occur between the active children who are receiving salaries and bonuses, and the inactive children who are not. By having the active children own life insurance on a senior family member’s life, a “bank” is created to provide the funds to satisfy any such puts and calls. Usually, the policy will be owned outside of the business entity, such as in a trust for the benefit of the active children, or by a limited liability company owned by the active children.

1B.19 PROVIDE/EQUALIZE INHERITANCE FOR CHILDREN FROM A PRIOR MARRIAGE

Another common equalization technique involves families where the children from the first marriage are significantly older than the children from the second marriage or the children from the first marriage are significantly older than their stepparent. Rather than having the older children wait for their inheritance until their stepparent dies or until their stepsiblings come of age, an ILIT can be used to either provide an immediate inheritance for the older children without endangering the financial security of the stepparent and/or younger stepsiblings.

1B.20 PROVIDE CREDITOR PROTECTION TO THE INSURED

An ILIT can provide creditor protection to the insured-grantor. If the insured were to own an equity-building life insurance policy in his or her own name, the equity may, depending on state law, be subject to the claims of the insured’s creditors. Also, if the life insurance proceeds are payable to the insured’s probate estate, revocable living trust or to a testamentary trust to be established under the insured’s will, the proceeds may be subject to the claims of the insured’s creditors and the creditors of the insured’s estate, depending on state law. However, if an ILIT owns the life insurance policy, and the insured makes annual gift contributions to the ILIT that are not fraudulent conveyances (and the insured has not retained a beneficial interest in the ILIT24), the life insurance policy and its equity should be insulated from the claims of the insured’s creditors. Additionally, through the use of loans by the ILIT trustee, the ILIT’s equity could be indirectly “made available” to the insured- grantor. See, section 14.13, below, for a discussion of trustee loans to a non-grantor insured spouse.

1B.21 PROVIDE A HEDGE AGAINST REPEAL OF THE FEDERAL ESTATE TAX

Regardless of how the federal estate tax situation evolves, the characteristics of life insurance make an ILIT a unique hedge against both the uncertainty of the tax law and the certainty of mortality. An ILIT ensures predictable results whether the estate tax is repealed or not, whether transferred assets are treated as having a stepped-up or carry- over income tax basis, and whether the insured lives for one year or twenty-five years; with an ILIT, the insured wins either way.

1B.22 PROVIDE A HEDGE AGAINST THE PREMATURE DEATH OF AN ANNUITANT

A grantor-retained annuity trust (“GRAT”) is an irrevocable trust to which the grantor transfers a rapidly appreciating asset, (i.e., appreciating greater that the IRC section 7520 rate that is used to value the gifted remainder interest in the GRAT), such as a closely held business interest, while retaining the right to receive a fixed annuity from the trust for a stated term of years. The longer the stated term and the larger the annuity, the smaller the taxable gift. At the end of the GRAT’s stated term, the trust property passes gift tax free to remainder beneficiaries. The risk of a GRAT is that if the grantor dies during the annuity term of the GRAT, the IRS has taken the position that the grantor’s retained annuity interest causes some or all of the value of the GRAT to be included in the grantor’s gross estate for federal estate tax purposes pursuant to IRC sections 2036 and 2039.9 IRC sections 2036 and 2039; TAM 200210009. By funding an ILIT for the benefit of the GRAT’s remainder beneficiaries, however, the grantor can leave the assets to the GRAT’s remainder beneficiaries, who will then use the life insurance proceeds to pay the federal estate taxes due. Alternatively, a married grantor might qualify the assets in the GRAT for the marital deduction and have an ILIT (for the benefit of the GRAT’s remainder beneficiaries) use the life insurance proceeds to purchase the assets from the grantor’s estate. See also, section 14.3, below. An ILIT can also be useful where the grantor has sold an asset in exchange for a private annuity.10 In a private annuity transaction, the purchaser is obligated to pay the annuity amount for the lifetime of the grantor-annuitant. When the annuitant dies, the payments under the annuity cease, and the value of the “unpaid” annuity is not included in the annuitant’s gross estate for federal estate tax purposes. When utilizing a private annuity arrangement, the purchaser, who is personally obligated to pay the annuity, can fund an ILIT for the benefit of the purchaser’s family so that they will have the cash to continue to pay the private annuity amount should the purchaser predecease the annuitant. Conversely, the annuitant can fund an ILIT for the benefit of his or her family as a hedge against the annuitant’s premature death. In either case, the amount of life insurance needed would be based on the present value of the future annuity payments. See also, section 14.8, below.

A variation on the same theme involves the grantor’s sale of an asset in exchange for a self-cancelling installment note (“SCIN”). With a SCIN, upon the grantor-seller’s death, all remaining payments under the promissory note are canceled, similar to a private annuity. The purchaser must pay a “premium” for this cancellation feature, either by a higher interest rate or by a higher purchase price. Like a private annuity, upon the seller’s death, the value of the “unpaid” SCIN is not included in the seller’s gross estate for federal estate tax purposes. When using a SCIN, just as with a private annuity, the seller can fund an ILIT for the benefit of his or her family as a hedge against the seller’s premature death. Conversely, the purchaser in a SCIN transaction can fund an ILIT for the benefit of his or her family so that they will have the cash to continue to pay the SCIN should the purchaser predecease the seller.

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