Life Insurance is a key component of many estate plans. As discussed in our article, Uses of Life Insurance in Estate Planning, Life Insurance is a multi-faceted tool that can help you and your family address a variety of needs.

If properly implemented as part of a comprehensive Estate Plan, Life Insurance can be a powerful ally in your Estate Planning process.

The Liquidity Issue

One of the most common uses of Life Insurance in Estate Planning is to provide liquidity for your heirs to pay the Federal Estate Tax at pennies on the dollar.

This continues to be one of the most popular techniques for reducing one’s Estate Tax burden. The reason for its popularity is that – in the end, the IRS gets its money. Therefore, they have no incentive to challenge or audit your estate, since they have been paid in full.

Other techniques, which may rely on discount valuation methods, actually reduce the IRS’s take at the end of the day. Consequently, the IRS is much more likely to challenge these methods – especially those which rely on aggressive valuation discounts. In the view of the IRS – it’s nothing ventured nothing gained.

Careful Planning is Essential

What most people are unaware of, however, is that the death benefit paid out by a life insurance policy will actually INCREASE your Gross Estate value – if proper planning is not done.

Even though you bought the life insurance policy to pay off your Estate Tax Liability, you wind up increasing your Estate Tax liability, thereby making it necessary to buy even MORE life insurance to pay off the estate taxes that the first policy increased.

And on and on, the endless Life-Insurance-and-Estate-Tax merry-go-round keeps spinning.

Fortunately, however, there is a way to stop the endless spinning – it’s called the Irrevocable Life Insurance Trust (ILIT).


An ILIT is an irrevocable trust that holds all of the “Incidence of Ownership” of your life insurance policy. This means that, for Estate Tax purposes, the Trust (and not you) are the owner of the life insurance policy.

Since the policy does not belong to you, it will not be included in your Gross Estate upon your death, and it’s death benefit will pass Estate and Income Tax free to your heirs.

There are a few catches to this otherwise excellent strategy. One of these is the IRS position that gifts to an irrevocable trust are gifts to the beneficiaries. The IRS has further stated that the payment of Life Insurance premiums by you are actually gifts to the beneficiaries. Gifts that exceed the Annual Exemption amount (currently, $14,000 per year), are taxed on a sliding scale that currently (2014) tops out at forty (40%) percent!

For an added IRS position guaranteed to make your head swim: since the Life Insurance premiums are future gifts to the beneficiaries – who don’t enjoy the benefits until after your death – the $14,000 Annual Exemption does not apply. The general rule is that the Annual Exemption does not apply to future gifts – only to present gifts.

So what can be done?

Enter the Crummey Powers (Not as bad as it sounds)

Back in 1968, a local San Jose man by the name of D. Clifford Crummey, faced the same challenges you do. How to apply the Annual Exemption to the life insurance premiums he was paying to his Irrevocable Trust?

In the court case that ensued, which is known today as the Crummey decision, the court ruled that a gift to a Trustee on behalf of the beneficiaries is a present-interest gift to the beneficiaries – and therefore, the Annual Exemption amount applies.

Here’s how it works:

(1) The Donor pays the premiums to the Trustee of the ILIT

(2) Simultaneously, the Donor sendsCrummey letters to each of the beneficiaries, advising them of their right to withdraw the money donated on their behalf. This right usually exists for a standard period of time – typically thirty (30) days.

(3) If the beneficiaries sign the Crummey letter, and refuse to withdraw the money to which they are entitled, then the Trustee goes ahead and pays the Life Insurance premiums on their behalf;

(4) If the beneficiaries take no action during their window of opportunity – then they will have been deemed to waive their rights, and the Trustee goes ahead and pays the Life Insurance premiums on their behalf.

How Much Money can be Used for Premiums?

Under current (2014) tax law, the Annual Exemption is $14,000 per donor ($28,000 for married couples, filing jointly).

Bear in mind, this Annual Exemption applies to each beneficiary, thereby greatly expanding the Annual Exemption amount.


Husband and Wife have three children, and wish to pay premiums to an ILIT on their children’s behalf.

$14,000 x 2 spouses = $28,000 x 3 children = $84,000

Therefore, under current tax law, they are able to exempt $84,000 from Gift Tax!

Therefore, they are able to purchase a Life Insurance policy and have the entire premium fit under the Annual Exclusion amoung, so long as the premiums do not exceed $84,000 per year.


A properly drafted and funded ILIT can be a tremendous Estate Tax Planning vehicle for you and your family. It allows you to satisfy your Estate Tax obligations for mere pennies on the dollar!

This is a time tested and IRS-approved means of reducing your Estate Tax liability.

Like all other Estate Planning techniques, the assistance of legal counsel is invaluable.

We invite you to meet with one of our attorneys to discuss your Estate Planning needs in greater detail.

John Erik Fraker, Esq.

View all posts

John Erik Fraker, Esq.

Call Now Button