Question 1

What is an ILIT and why do New York estate planners use them?

Accepted Answer

An irrevocable life insurance trust (ILIT) is an irrevocable trust that owns one or more life insurance policies on the grantor's life. Because the trust — not the grantor — owns the policy, the death benefit is not included in the grantor's taxable estate under IRC §2042, provided the grantor has no 'incidents of ownership' in the policy and has not transferred the policy within three years of death. For New York clients with taxable estates, this can save substantial estate taxes: a $5 million death benefit owned outside the estate and received by an ILIT passes to beneficiaries free of estate tax, while the same benefit received outright by the grantor's estate could trigger hundreds of thousands of dollars in New York and federal estate taxes. The ILIT functions as follows: the grantor creates the irrevocable trust and names beneficiaries (typically family members). The trust applies for and owns a new life insurance policy on the grantor's life, or the grantor transfers an existing policy to the trust (subject to the three-year rule for transfers of existing policies). The grantor makes annual cash gifts to the trust — using the annual exclusion ($18,000 per beneficiary in 2024) or the gift tax exemption — and the trustee uses those funds to pay the insurance premiums. Upon the grantor's death, the death benefit passes income-tax free and estate-tax free to the trust, which then distributes to or holds for the benefit of the named beneficiaries. The ILIT can also be structured to provide the estate with liquidity — through a loan or purchase of estate assets — to pay estate taxes, even while the death benefit itself stays outside the estate.

Question 2

What are Crummey powers and why are they essential for ILITs in New York?

Accepted Answer

For a gift to an irrevocable trust to qualify for the gift tax annual exclusion ($18,000 per donee in 2024), the gift must be a present interest — meaning the beneficiary must have an immediate, unrestricted right to use and enjoy the gift now, not merely in the future. Trust gifts are generally future interests because the beneficiary's enjoyment is delayed until the trustee chooses to distribute. The Crummey power (named after the seminal Tax Court case Crummey v. Commissioner) solves this problem by giving trust beneficiaries a temporary right — typically 30 to 60 days — to withdraw contributions made to the trust. Because the beneficiary has an immediate right to withdraw, the gift qualifies as a present interest eligible for the annual exclusion. As a practical matter, beneficiaries almost never exercise their Crummey withdrawal rights — doing so would defeat the purpose of the trust and consume funds intended for insurance premiums. But the withdrawal right must be real and must be communicated to the beneficiary in writing (the 'Crummey notice') each time a contribution is made to the trust. Failure to properly administer Crummey notices — a common error in self-managed ILITs — can disqualify the annual exclusion and result in unexpected gift tax liability. Morgan Legal Group drafts ILIT agreements with proper Crummey provisions and assists trustees with ongoing Crummey notice administration for New York clients across all five boroughs and surrounding counties.

Question 3

What happens if I transfer an existing life insurance policy to an ILIT in New York?

Accepted Answer

Transferring an existing life insurance policy to an ILIT — rather than having the ILIT apply for a new policy from the outset — triggers the three-year rule under IRC §2035. This rule provides that if a grantor transfers a policy to an ILIT within three years of death, the death benefit is pulled back into the grantor's gross estate for federal estate tax purposes, negating the transfer's estate tax benefit. The three-year rule does not apply if the grantor made a cash gift to the ILIT and the trustee then applied for and purchased the new policy — because the grantor never owned the policy in the first place. For this reason, when planning allows, it is almost always preferable to have the ILIT established before any new policy is purchased, so that the trust is the original applicant and owner. If a grantor has an existing policy with significant cash value or is uninsurable for new coverage, transferring the existing policy to an ILIT may still make sense as an estate planning strategy, with the understanding that the three-year rule applies and the insured should survive at least three years after the transfer for the estate tax benefit to be realized. The gift tax value of the transferred policy — typically its interpolated terminal reserve value plus unearned premium — must be reported on a federal gift tax return. Morgan Legal Group counsels New York clients on both new ILIT formation and existing policy transfers, providing full analysis of the three-year rule and any gift tax implications.

Question 4

How can an ILIT provide estate tax liquidity for a New York estate?

Accepted Answer

One of the most powerful uses of an ILIT for New York estates is as an estate tax liquidity vehicle. Estate taxes in New York are due within nine months of the decedent's death — and they must be paid in cash. For estates whose wealth is concentrated in illiquid assets such as real estate, closely held business interests, or investment portfolios that cannot be liquidated quickly without significant value loss, meeting the estate tax deadline can be a serious problem. An ILIT can solve this liquidity problem elegantly. Because the ILIT receives the life insurance death benefit outside the estate (and thus free of estate tax), the ILIT has a large pool of liquid cash available immediately upon the insured's death. The ILIT, however, is a separate legal entity — the estate cannot simply take the cash, as that would cause the proceeds to be pulled into the estate. Instead, the ILIT can purchase estate assets from the estate (at fair market value), providing the estate with the cash needed to pay taxes while transferring assets to the trust. Alternatively, the ILIT can make a loan to the estate, secured by estate assets, which the estate repays over time. Both techniques provide the estate with immediate liquidity while maintaining the estate tax exclusion of the insurance proceeds. For New York business owners, real estate investors, and families with illiquid estates, ILIT planning is one of the most practical and cost-effective estate tax planning strategies available. Russel Morgan designs ILIT structures with estate liquidity explicitly in mind for New York clients throughout the metropolitan area.

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