GoFisch blog

Mark Twain famously said, “A classic is something everybody wants to have read, but no one wants to read.” Life insurance is a little like that. Everyone needs it, but we don’t like to talk about it much.

Life Insurance as Key Estate Planning Tool

Life insurance is an amazing estate planning tool. I cannot stress enough the importance of life insurance. I, of course, don’t sell it, so I have no economic stake here. It’s just that life insurance is generally reasonably and affordably priced, yet still so helpful with so many financial goals. Replacing a breadwinner’s earnings is one of the most commons ways it is utilized. But, it can also provide liquid assets for a small business when a key partner dies.  Life insurance can also cover costs that you might forget about, like funeral costs or unpaid taxes.

A great resource for learning more about life insurance is an interview I did with insurance agent and industry expert, Christa Payne. (If you are an Iowan, you can just email Christa – she’ll be happy to answer any questions you have.)

While there are many advantages to life insurance, and you most definitely need it, life insurance can also create estate planning issues.

Three Estate Planning Issues Life Insurance May Create

The major issue created by life insurance is that of the “sudden windfall” to your beneficiary. Do you really want, say, your 19-year-old to inherit several hundred thousand dollars at once? Even oldsters with experience managing finances may find a huge influx of cash to be overwhelming.

Another issue to consider: does your beneficiary receive government benefits? If so, proceeds from your life insurance policy might make your beneficiary ineligible for further benefits. By the way, don’t think that those receiving government aid are all elderly. Quite the opposite! A vast majority of Medicaid recipients are under age 44. Regardless of age, any beneficiary on Medicaid, or similar government aid program, is at risk of losing benefits without careful estate planning.

Finally, for high-net worth (HNW) individuals and families, there is the issue of the federal estate tax. Everything owned in your name at death is included in your estate for estate tax purposes. Yes, that includes the death benefit proceeds of your life insurance policy. Considering that many policies carry quite hefty death benefits (several hundred thousand dollars, or more, not being unusual), this is definitely something for those with HNW to carefully consider.

Older person looking out at water

Photo by Ian Schneider on Unsplash

In Trusts we Trust

I’ve explained trusts generally before. A quick primer: in simplest terms, a trust is a legal agreement between three parties: grantor, trustee, and beneficiary. This allows a third party (the trustee) to hold assets for a beneficiary (or beneficiaries).

There are a nearly infinite variety of trusts. And, one type of trust is an Irrevocable Life Insurance Trust, or ILIT.

So, what IS an Irrevocable Life Insurance Trust?

Think of an ILIT as an “imaginary container,” which owns your life insurance policy for you. This provides several benefits. An ILIT removes the life insurance from your estate, i.e., lowers estate tax liability. Like other trusts, an ILIT allows you to decide how, when, and even why your named beneficiary receives life insurance proceeds.

Photo by Connor Betts on Unsplash

Wait, what was that about the three parties?

The grantor is you, the purchaser of life insurance.

The trustee can be anyone you, as grantor, chooses — an individual(s) or a qualified corporate trustee (like the trust department at your bank). But, note a major difference between an ILIT and other kinds of trusts – with a large number of other trusts, you can name yourself as trustee. With an ILIT, you wouldn’t want to do so, because the IRS may then determine that life insurance really hasn’t left your estate.

Who can be a beneficiary of an ILIT?

Most often, spouses, children, and/or grandchildren are the named beneficiaries of an ILIT. But really, it can be any individual(s) you, as grantor, choose.

Your beneficiary and your life insurance proceeds

The conditions under which a beneficiary receives distributions from an ILIT is up to you. You can, for example, specify that your beneficiary receives monthly or annual distributions. You can decide the amounts. You may even dictate that your beneficiary receives distributions when s/he reaches milestones which you choose. For example, you can provide for a large(r) distribution when a beneficiary reaches a certain age, graduates from college or post-graduate program, buys a first home, marries, or has a child. Or, really, just about any other condition or event that you decide is appropriate.

You also have the option to build in flexibility, so that your trustee has the discretion to provide distributions when your beneficiary needs it for a special purpose, like pursuing higher education, starting a business, making an investment, and so on.

And, of course, if your beneficiary is receiving government benefits, an ILIT can account for that, as well.

Good gosh, is there anything an ILIT CAN’T DO?

Once again, an ILIT is irrevocable. While an ILIT provides a great deal of flexibility, there’s one action for certain you can’t take — you cannot transfer a policy owned by an ILIT into your own name. So, if you think that someday you may need to access the policy’s cash value for your own purposes, you probably shouldn’t set up an ILIT.

Options for “ending” an ILIT

Now, I suppose, there’s nothing requiring you to continue making insurance payments into your ILIT. Depending on the kind of policy you have, your policy may lapse as soon as you miss your premium payment. Or, if your policy has cash value, these funds may be used to pay premiums until all the accumulated cash is exhausted. So, that’s an option for “ending” an ILIT.

I bet you have some questions. Let’s talk!

An ILIT can provide you, your loved ones, and your estate with significant benefits. To learn more, contact me at my email, gordon@gordonfischerlawfirm.com, for a free consultation, without obligation. You can also give me a call at 515-371-6077.


*Yes, you’re right – ILIT is really not a word, but an acronym. You caught me. It’s just that Legal Word of the Day sounds more exciting than Legal Acronym of the Day. Also, congratulations to you for being the kind of person who reads footnotes.

**In 2017, essentially, an individual must have an estate of more than about $5 million, and a married couple an estate of more than $11 million, before they need to worry about federal estate taxes.

Money sign against black screen

Charitable remainder unitrusts (CRUTs) are an important charitable giving tool. CRUTs can provide both an income stream and income tax deduction to you as well as a contribution to your favorite charity. In certain situations, though, a traditional CRUT may be limited in effectiveness. Two other types of CRUTs: the NIMCRUT and the Flip CRUT, can be useful alternatives. I’ll explain more about those below and have also written on them in the past.

How CRUTs Work

In a simple CRUT, the donor contributes assets to a trust and may take a current income tax deduction equal to the present value of the gift that will eventually be distributed to a worthy charity. The CRUT pays the non-charity beneficiary (the annuitant can be the donor, or someone else) a percentage of the trust assets, valued each year either for the annuitant’s life or for a term of years (not more than 20 years). At the end of the trust term, the remaining assets go to the charity (or charities) the donor named as beneficiary.

Giving flowers in open hands

Simple Example of a CRUT

Let’s say Jill Donor starts a CRUT, funding it with $1 million. Assume that the CRUT terms require the trust to pay Donor seven percent of the value of the trust assets each year for 20 years. Donor will receive a distribution of $70,000 in the first year. If the trust assets grow to $1.1 million in the second year, Donor will receive $77,000. At the end of the trust term, Donor’s favorite charity will receive the balance of the trust assets.

CRUT Defers Taxes on Appreciated Assets

CRUTs can be ideal vehicles to defer tax liabilities on appreciated assets. Why? Because the trustee of a CRUT can sell the appreciated assets transferred to the trust without incurring capital gains tax, although the annuitant is responsible for income tax on the payment she receives each year.

Going back to our example, if Donor sells $1 million of stock, for which she had paid $100,000, she will pay $180,000 in tax, leaving her $820,000. To receive the $70,000 annual income stream she needs, she will have to earn a 9 percent return. If instead she funds a CRUT with the stock, and the CRUT sells it, the full $1 million will be available to invest because the CRUT will pay no immediate capital gains tax.

Stocks & figures on paper

CRUTs and Currently Unproductive Assets

A traditional CRUT won’t work as well when funded with assets that produce no income, such as real estate. If the assets held by a CRUT do not produce enough income to meet the annual payment obligation, the trustee will be forced to use the trust corpus to transfer a portion of the assets back to the annuitant as a part of the payment. Of course, this will reduce the trust’s ability to produce income in the future and leave less for the charity at the end of the trust term.

NIMCRUT Can Hold Currently Unproductive Assets

If Jill Donor in the example were interested in funding a CRUT with assets that are currently unproductive, but likely to be productive at some point over the trust term, she should consider using the net income with make-up CRUT (NIMCRUT) instead.

Under a NIMCRUT, the annuitant receives the lesser of either the net income earned by the trust during the year or a fixed-percentage amount. A make-up account is established for years when the trust pays less than the percentage amount, and any shortfall is made up in years the trust earns more income than the percentage amount.

Using our previous example, if the NIMCRUT earns $60,000 in the first year, Donor will receive a payment in that year of $60,000, because this is less than the seven percent required amount. If the trust earns $90,000 in the following year, and assuming the value of the trust is still $1 million, Donor will receive a payment of $80,000—the $70,000 percentage amount, plus an additional $10,000 to make up for the prior year’s $10,000 shortfall.

By using a NIMCRUT, the trustee avoids having to distribute a portion of the trust corpus to an annuitant as part of the annual payment in years in which the trust does not produce enough income. Thus, a NIMCRUT preserves trust corpus while still, over time, paying the annuitant the percentage he or she is entitled to under the trust.

The trustee, however, may face another issue if the unproductive asset is sold. Generally, the terms of a NIMCRUT forbid the trustee to pay the fixed-percentage amount from capital gains or trust principal. Therefore, the trustee may feel pressured to invest for current yield, and produce additional income to make up prior shortfalls to the annuitant, rather than to invest for total return, which may better serve the long-term interest of the charitable beneficiary.

Money Rubix cube being twisted by haneds

Flip CRUT Can Benefit Annuity and Charity More Equally

To benefit the annuitant and the charitable beneficiary more “equally,” Donor, in our example, might be wise consider a Flip CRUT. The Flip CRUT begins as a NIMCRUT and can be funded with an unproductive asset. This allows the trustee to make small or even no payments to the annuitant in years the trust is earning little or no income. Once the asset is sold, however, the trust flips to a traditional CRUT, which then pays the annuitant the fixed-percentage amount, allowing the trustee to invest for total return.

For instance, using our prior example, if Donor funds a Flip CRUT with an unproductive asset valued at $1 million, the trust will earn no income and Donor will receive no annual payments. When the trust assets are sold and invested in income-producing assets, Donor will begin to receive fixed percentage payments of 7 percent of the trust assets as valued each year, but will receive no make-up for payments not received in prior years.

To qualify as a Flip CRUT, though, at least 90 percent of the fair market value of the trust assets must be unmarketable at the time of trust funding, and the trust’s governing instrument must provide that it will be a NIMCRUT until the unmarketable assets are sold. At that point, it will flip to a standard CRUT and the annuitant will forfeit any make-up payments.

CRUTs, NIMCRUTs and Flip CRUTs

If you want to make a charitable donation while retaining an income stream that can continue for the benefit of your spouse or children? CRUTs, NIMCRUTs and Flip CRUTs can all be effective estate planning techniques to reach these worthy goals.

Wealth is of the heart and mind

Let’s Talk

This concept can be confusing, so don’t hesitate to reach out for more information and explore how a charitable remainder unitrust could be beneficial to you. Feel free to contact me at any time at Gordon@gordonfischerlawfirm.com or by phone at 515-371-6077.