News

New research on Irrevocable Life Insurance Trusts (ILITs)

Edition 2011-2 of the News page on our website, www.comp-strat.com, outlined our research on ILITs. It presented a range of options for taking advantage of the temporary increase to $10MM in the Federal lifetime limit on a couple’s non-taxable gifting.

One of the clients who asked for a copy of our full research paper came back with a question we had not addressed. He wanted to know: How does gifting to avoid estate taxes differ from staying put and passing on this two year window of opportunity?

We went back to the drawing boards and developed some answers. The results are presented in the four accompanying charts. From our reading of them we draw these observations:

1. Chart 1 shows that gifting to an irrevocable trust in 2011 or 2012 may increase the Net-to-Heirs by more than 15%, regardless of a couple’s current ages, if the investment returns average 8.00%.
2. Chart 2 shows that the trust’s $ advantage is reduced if investment returns are lower, but the % advantage of gifting is only slightly reduced.
3. Charts 1 & 2 present a similar picture: delayed gifting cuts in half the gains from gifting in 2011 or 2012. Still, waiting until 2013 to establish the trust is better than doing nothing.
4. Gifting in 2011 or 2012 into an irrevocable life insurance trust may produce the best Net-to-Heirs result. Chart 3, with an assumed investment return of 8.00%, suggests that an ILIT may increase the Net-to-Heirs for a couple now age 50 by 60%.
5. With an investment return of 7.00% (Chart 4), early gifting to an ILIT may increase the Net-to-Heirs by about 48%.
6. Gifting to an ILIT may be expected to produce a superior result whenever the second death occurs. And, the life insurance feature will add materially to a couple’s estate in the unlikely event of a catastrophic event.
7. The better outcome from an ILIT is due to the insurance arbitrage. Insurance charges average down year by year as a % of a policy’s current asset value and in two or three years may be less than the taxes paid by a taxable trust. The taxes paid by a taxable trust (and not paid by the ILIT), however, grow in direct proportion to the trust’s return on its assets.

All four charts are based on tax rates in the State of Connecticut. We assumed that each couple will make a full marital transfer to the surviving spouse and that the second death will occur at the couple’s joint life expectancy.

Charts 1 & 2 compare the amounts received by the heirs of seven HNW couples now age 45, 50, 55, 60, 65, 70 and 75. Each couple has a current net worth of $20MM. The Net-to-Heirs calculations assume that the second death occurs at each couple’s joint life expectancy. We examined three scenarios: (a) a $5MM gift to an irrevocable trust in 2011, (b) gifting the same amount to an irrevocable trust in 2013 and (c) not gifting to an irrevocable trust.

Charts 3 & 4 are focused on the couple both now age 50. They compare the Net-to-Heirs under three scenarios: (a) gifting $5MM to an ILIT in 2011, (b) gifting the $5MM in 2011to an irrevocable trust that does not invest in a life insurance contract and (c) not gifting to an irrevocable trust.  

The purple lines in Charts 3 & 4 graph the probability that the second death will occur at each age from 50 to 99.

All four charts assume that any investment taxes due on a trust’s investment returns are paid by the trust.

We welcome your comments and will be pleased to discuss your questions or provide information about designing and funding an irrevocable life insurance trust to complement your other estate planning strategies.

Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice. FSC Securities does not offer tax, estate planning or legal advice.