Top 5 Responsibilities of an ILIT Trustee
An ILIT is an Irrevocable Life Insurance Trust, created primarily to own life insurance, and sometimes other assets. The trustee of an ILIT is the fiduciary of the trust assets. The trustee can be a family member (who is not the creator or ‘grantor’ of the trust), or an independent trustee at a bank, for example. Regardless of who is named trustee, the trustee has a fiduciary responsibility to manage assets for the benefit of trust beneficiaries.
Many states have adopted the Uniform Prudent Investor Act, which requires that trustees act prudently in making trust investments. Trustees should become familiar with statutes for the states in which the trust is domiciled and must establish a process for determining suitability of trust-owned life insurance on an ongoing basis.
Sometimes life insurance is mistakenly viewed as a passive asset by trustees and this view could subject them to an unintended breach of fiduciary duties, and legal liability. In other words, policies need to be monitored for performance based on changing internal costs, as well as the sufficiency of current premium payments and how any withdrawals or loans outstanding may impact the policy over time. In fact, policies need to be monitored to ensure against risk of lapse and to identify options so that the objectives of the policy are met. Trustees of ILITs have 5 primary responsibilities:
- Payment of Life Insurance Premiums. Life insurance policies typically have ongoing premiums. Those premiums can be scheduled to be paid for a limited number of years based on the funding design, or as annual premium payments. In some cases, there may be a single, first year premium. The trustee will collect premiums when due to fund the policy. The trustee must also ensure that there is sufficient cash in the trust to pay the premium or any additional required, and if not, determine what options are available (i.e., take loans or withdrawals from the policy, for example, if feasible). Non-payment or insufficiency of premium payments can lead to unintended lapse of the policy. A lapse of a policy may also trigger taxation. The trustee may be directly liable for a lapse of a policy and any consequences thereof, as seen in the 2016 John N. Thomson 6th circuit court case. [1]
- Providing Notice of Gifts to Beneficiaries. When a gift of premium is made to the trust, the beneficiaries must be notified of the payment. That is, the trustee must notify the beneficiaries that they each have a right to withdraw the gift of premium before it is sent to the insurance company. Typically, the trustee allows 30-60 days before that right lapses. The trust document will dictate how notice to the beneficiaries is to be made. Often, a trustee provides a written notice to each beneficiary and may require the beneficiary to sign the receipt of notice. The purpose of these notices is to enable the gifts to qualify as ‘present interest gifts’ so they are covered by the ‘annual exclusion’ from gift taxes. If the rules are not administered properly, it is possible that the gifts will be taxable.[2]
- Review of Policy Performance. The trustee should review the life insurance policy periodically to determine if the policy is performing as expected and should engage the services of an insurance specialist. It is imperative that any risk of policy lapse be considered since the lapse of a policy may also trigger substantial taxation. The trustee should assess, as well, whether the amount of insurance coverage continues to be sufficient for the beneficiaries.
- Investment Management. A policy review will help the trustee determine if the policy continues to be an appropriate investment of the trust based on stated objectives. Some life insurance policies require active management of investment options underlying the policy. The trustee can engage an investment professional to manage the investment options if so desired. However, the trustee is ultimately responsible for the policy’s performance and must be able to justify the investment choices made. In addition, monitoring policies with loans or withdrawals to assess sustainability is a critical part of the investment management by the trustee. Moreover, the repayment of a loan, or its refinancing will require the trustee to manage the assets accordingly.
- Tax Reporting. Most often, ILITs do not have taxable income. However, sometimes trusts are funded with income producing assets, such as stock, real estate or bond funds, for example. In these cases, if the trust is designed as a “Grantor Trust” for income tax purposes, then the income and deductions from the trust are reported by the grantor on his or her tax return. If the ILIT is not a “Grantor Trust”, then the income and deductions must be reported on the trust tax return (Form 1041). Tax reporting is required, as well, when an ILIT is designated as beneficiary of assets scheduled to pour into it from another trust.
[1] See John N Thomson, v. Hartford Casualty Insurance Company, 2016 WL 4036403, No. 15-1501 (6th Cir. July 28, 2016)
[2] See Crummy v. Commissioner, 397 F.2nd 82 (9th Cir. 1968). See Hattleberg v. Northwest Bank Wisconsin, 2005 WL 1574958 (2005) in which gifts to trust did not qualify as annual exclusion gifts and trustee was held liable for taxes incurred.
