1. Types of Life Insurance - Term
No cash value
Expires if premiums are not paid
May have fixed premiums for a certain number of years
After this, premiums may go up or the policy may be cancelled
Premiums are typically low, depending on the health of the insured
The typical choice for young heads of families who are looking to protect the family in the event of an untimely death

2. Types of Life Insurance – Whole Life
“Insurance” and “cash value” components
Cash value can appreciate at a high interest rate
Builds up “cash value” that can be withdrawn or borrowed against
Premiums are higher
If premiums are not paid, the cash value can be used to pay the premiums
Never “expires” unless the premiums are not paid and there is no cash value left
Typical for people who want to
Use the policy as a savings tool
Use the death benefits to pay the estate tax or other post death expenses
Other forms of policies such as variable life, etc., are forms of whole life policies or combinations of whole life and term policies

3. Parties to a Life Insurance Contract
Owner
This person or entity has legal title over the policy
Pays premiums and can change beneficiaries
Insured
The policy is on this person’s life
Beneficiary
Will receive the death benefits after death of the insured
Owner and insured are often the same person. The beneficiary may be a spouse or children of the insured, etc.

4. Insurable Interest
The owner (not the beneficiaries) of the policy must have an insurable interest to purchase a policy.
The policy can be sold later on to someone without an insurable interest, however.
Typical state rules allow the following people to have an insurable interest:
Spouse of the insured
Other close relatives (depends on the state how close)
Business partners and other business relations that will be hurt if the insured dies

5. Income Taxation
Cash value that is withdrawn is only taxable when the total amount withdrawn exceeds the total amount paid in premiums on the policy.
Otherwise, the withdrawal is not a profit.
Death benefits of life insurance policies are excluded from gross income under Section 101 of the I.R.C.
However, the recipient must have an insurable interest in the insured for this exemption to apply.
Otherwise, the recipient can still receive the death benefits, but must pay income tax on the proceeds.
If the recipient paid part of the premiums or bought the policy as an investment, income tax applies only to the profits made on the transaction.

6. Irrevocable Life Insurance Trust
The ILIT typically either purchases the policy or has the policy transferred to the trust after it is purchased.
The ILIT is useless unless the policy is actually transferred to the ILIT.
It’s the job of the drafting attorney to ensure that the policy is transferred.
This may be done by the attorney or the client usually with help of the life insurance agent.
Whether transferring the policy is part of the fee for preparation of the trust should be discussed with the client initially.
Two or more policies may be held in one ILIT.

7. ILITs and Estate Taxation
LI policy death benefits are in the estate of the insured if, at any point within three years of death, the insured exercised “incidents of ownership” over the policy.
Incidents of ownership include:
Right to change beneficiaries
Right to borrow money against the policy
Right to assign the policy, modify, or revoke the trust
So, to ensure that the death benefit is not in the estate of the insured, you should:
Have the trust buy the policy OR make sure to transfer it as early as possible to get it into the trust three years prior to the death of the insured
Make sure not to give the insured any power relative to the trust that would be considered an incident of ownership

8. ILITs and Estate Taxation 2
Beyond the 3 year and incidents of ownership rules, the trust can be treated similarly to any trust that is supposed to be outside the estate of the grantor.
So:
The insured’s spouse and family can be beneficiaries of the trust
The grantor’s spouse can be made a beneficiary just to the extent necessary to keep the trust assets outside of her estate
Etc.

9. Gift Tax Issues and ILITs
If the ILIT owns a trust, paying the premiums is considered a gift to the trust.
The best thing is to have the client transfer the money to the trust and the trust pay the premiums
However, if the insured pays the premiums directly, it probably is also okay
To ensure that the gifts are eligible for the annual exclusion, Crummey withdrawal powers can be given to the trust beneficiaries
The beneficiaries who have a present possibility of receiving trust benefits are best to use in this capacity
You want to try to use beneficiaries who are unlikely to use their Crummey power
A withdrawal demand can interfere with the payment of the premiums

10. Creditor Protection
Life insurance cash values are protected to some extent from creditors of the insured.
Federal law provides some protection
States may provide additional protection
Once paid out, of course, the death benefits are subject to the recipient’s creditors.
If there are beneficiaries with creditor problems, a separate spendthrift trust can be established to hold that beneficiary’s share.
The same is true for beneficiaries receiving government benefits. That beneficiary’s share can be held in a separate trust that will not pay expenses that would otherwise be paid for by government assistance.

11. Grantor Trust Status
Under Section 677, most ILITs are inherently grantor trusts.
However, they can be specifically tailored to be non-grantor trusts as well.
This may be desirable when the grantor makes enough money to be in a very high income tax bracket.
The simplest way to make an ILIT into a non-grantor trust is to require the consent of an “adverse party” before the trustee can pay life insurance premiums on the life of the grantor.

12. When is an ILIT a Good Idea?
An ILIT has many tax and other advantages, but does decrease the flexibility of the owner in terms of handling the policy.
Term policies can usually safely be placed into trust since there is no cash value and so flexibility is less important.
With regard to whole life policies, clients often want to be able to access the cash value, which is impossible under the terms of an ILIT.
So, an ILIT may be advisable only where the death benefit amount is high and estate tax and/or creditor protection is a major concern.

13. Ethical Issues Confidentiality Referral fees Reciprocal Advice
The insurance broker and other professionals involved in the policy are not entitled to any information and should not be given information about the client or the plan unless the client gives prior consent.
Referral fees
Giving any non-law a referral fee, including a life insurance agent, is unethical.
Reciprocal Advice
An attorney should never agree to recommend that the client buy a policy in exchange for a referral.
An attorney should only advise the purchase of a policy if s/he believes in good faith that such purchase is in the best interest of the client!