Take-Away: With an increasing interest in individuals purchasing life insurance to provide estate liquidity with her applicable exemption schedule to drop by over 50% in the next four years, there is renewed interest in life insurance trusts. Those asked to serve as the ILIT trustee should think twice before accepting the position as trustee of the ILIT.

Take-Away #2: TV pitch-man Ron Popeil’s “Just Set It and Forget It” was not talking about ILITs.

Background: There are many undercurrents at work causing individuals to consider purchasing life insurance as part of their portfolio of assets. Asset values have dramatically increased over the past decade along with lower income tax rates caused by the 2017 Tax Act.

There are now bills pending in Congress that seek to lower an individual’s applicable exemption amount from $11.7 million to $5.0 million. Other Congressional bills would prevent the long-standing strategies that shift wealth gift tax-free, e.g. curtailed GRATs, IDGTs, GRAT grantor trusts, GST-exempt dynasty trusts, etc. Then there is the President’s proposal to cause capital gains to be recognized with regard to appreciated assets on the owner’s death.

Finally, the high $11.7 million applicable exemption amount is already scheduled to drop to $5.0 + million beginning in 2026. All of these ‘undercurrents’ prompt many to re-examine the need for liquidity in their estates, liquidity often furnished with life insurance. The death benefit paid under a life insurance contract can be structured as being income tax-free to the recipient. If a trust (and ILIT) owns the life insurance policy and not the insured, the death benefit escapes estate tax. And if the President’s ‘deemed sale on death’ proposal becomes the law, the death benefit will not be taxed as a capital asset, meaning the paid death benefit would not be subject to the deemed disposition tax that is being proposed.

There are obvious benefits to using an ILIT to own and hold a life insurance policy to meet these potential liquidity demands, but great care should be taken in who or what is named as the trustee of an ILIT.

Fiduciary Duties of an ILIT Trustee: Several practical considerations go into the selection of an ILIT trustee, given the nature of the trust, the purposes of the trust, the goal of obtaining the tax attributes of the ILIT, and the sophistication required to administer such a trust. An ILIT trust should have their own liability insurance, should have experienced personnel, must understand the ILIT’s infrastructure, and hopefully provide a continuity of personnel inasmuch as an ILIT could run for several decades before the insured dies. The following is a list of some of the fiduciary duties normally associated with an ILIT:

  1. Administer the ILIT according to its terms;
  2. Administer the trust and act solely in the interests and for the benefit of the ILIT beneficiaries- the duty of loyalty;
  3. Deal impartially with the multiple beneficiaries of the ILIT when investing and managing and making distributions from the ILIT- duty of impartiality;
  4. Avoid any self-dealing;
  5. Control and protect the trust property;
  6. Make the trust property productive;
  7. Keep the trust property separate from the trustee’s own property;
  8. Diversify trust investments; and
  9. Comply with the Prudent Investor Rule.

Prudent Investor Rule: A life insurance policy is simply another asset that a trustee may invest in as part of the trustee’s responsibility to invest trust assets consistent with the Uniform Principal and Income Act. The duty imposed by the Act rekquired that an ILIT trustee act objectively, meaning what would a prudent person believe to be a proper course of action.. If a prudent person would know that an action should not be taken and the trustee takes the action anyway, then the trustee faces liability for breach of trust.

As life insurance policies become increasingly complex with a multitude of options and insurance ‘riders,’ the need to annually monitor the policy and its performance dramatically increases the burdens on the ILIT trustee. As a result, the trustee must keep records of their actions, including the trustee’s deliberations, the basis or reasoning for taking such actions, the information provided to the trustee and the beneficiaries, and all waivers and consents sought from the beneficiaries to comply with the Uniform Act’s ‘prudence’ requirement. Consider French v. Wachovia Bank NA, 2013 U.S. App. LEXIS 14399 (7th Cir. 2013) where an ILIT trustee was found to have breached it duty of care, skill and caution required by Sections 2a and 3 of the Uniform Act where the new insurance policies purchased by the trustee were determined (based on policy selection and performance) to be a ‘bad investment.’

Existing ILITs: Holding a life insurance policy in an irrevocable trust can create challenges to the trustee of an ILIT. Consider today’s very low interest rate, and low return investment environment, along with longer life expectancies of the insured. These conditions have caused life insurance companies to incur higher expenses, which in turn have caused existing life insurance policies to both under-perform and reduce expected cash surrender values. This confluence of circumstances can lead to required premium payments for a longer period of time, or a higher amount of cash outlay, and/or a reduced death benefit. In some cases, these circumstances, if unattended to by the trustee, might cause the life insurance policy to lapse. Additionally, some life insurance policy guarantees can be altered by the trustee’s action or inaction.

Trustee Responsibilities: Just some of the responsibilities of an ILIT trustee include:

  1. Open a trust account from which insurance premiums are paid;
  2. Select appropriate life insurance policies based upon the trust’s objectives and the insured’s circumstances; this includes the trustee’s obligation to be able to justify the investment choices under some policies, e.g. universal life insurance
  3. Review specific policy design and assumptions and assess if the policy will perform consistent with stated assumptions; This entails engaging the services of an insurance specialist to evaluate the risk of policy lapse and to asses whether the amount of insurance coverage continues to be sufficient for the benefit of the ILIT’s beneficiaries.
  4. Timely pay the policy premiums;
  5. Manage all the trusts assets beside the insurance policy;
  6. Make income and principal distributions to beneficiaries in accordance with the ILIT’s standards;
  7. Send Crummey notices if annual exclusion gifts are used to pay the life insurance policy premiums;

– In Hattieberg v. Northwest Bank Wisconsin, 2005 WL 1574958 (2005) the annual gifts made to the ILIT did not qualify as annual exclusion gifts. The ILIT trustee was held liable for the gift taxes the donor incurred.

  1. Maintain trust records and prepare accounts and reports for the beneficiaries, which includes monitoring policies with loans or withdrawals to confirm the continued sustainability of the policies;
  2. Consult with beneficiaries with regard to their needs;
  3. Balance the needs of current and future beneficiaries;
  4. File federal and state income tax returns and pay the tax if the ILIT is not taxed as a grantor trust;
  5. Timely provide K-1s to the ILIT beneficiaries.

Conclusion: Many individuals have been named as trustee of an ILIT yet they operate on the Ron Popeil principle of ‘setting it and forgetting it.’ That approach is wholly inconsistent with the Uniform Principal and Income Act and the responsibilities that it imposes on ILIT trustees. Courts are only now holding ILIT trustees liable for their failure to monitor life insurance policies held in trust, ‘stress-testing’ those policies and not acting as fiduciaries with regard to their responsibilities. It may be time to revisit who is the trustee of the ILIT and whether they are capable of fulfilling their numerous responsibilities.