Look for alternatives to amending trust

June 25, 2012

Found yourself with a trust that doesn't work well in the market? Learn how you can change the situation.

Q: I established an irrevocable life insurance trust (ILIT) several years ago to own and be the beneficiary of my life insurance policy. But after market losses and an increase in the estate tax exemption, I'm not sure that the ILIT is such a good idea. Can the trustee of the trust transfer the assets, including ownership of the policy, out of the trust so that it has no assets?

A: Collapsing or amending the trust would be difficult, because the trustee's fiduciary obligation is to preserve the trust's property for the beneficiaries. But you can consider other options:

The trustee can "sell" the policy from the trust for its fair market value. Generally, fair market value is similar to the cash reserve value of a policy. Under some circumstances, however, the values could be different. For example, the trust policy has $100,000 of cash reserve value. The trustee may be able to sell the policy back to you for $100,000, which could be cash or other property having the same value. The trust would then be funded with $100,000 of cash or property. Thereafter, you would own the policy, and only the cash in the trust would be subject to the terms of the trust.

The trustee may have the right to distribute trust principal to one or more of the trust beneficiaries during the grantor's lifetime. So if the trust distributes the policy to a beneficiary, then the beneficiary could, in turn, gift the policy back to you.

You can stop paying premiums on the policy, or stop making gifts to the trust so that the trustee does not have funds to pay premiums. If the trust has no other property and the policy lapses, the trust terminates. Depending on the trust terms and local law, however, the trustee may be obligated to exercise any policy rights that may continue coverage or ask trust beneficiaries to make contributions.

Which solution you choose should depend on trust provisions, state law, and your ultimate objectives. Consult an estate-planning attorney to determine your best course of action. But before you consider terminating an ILIT or removing the insurance from the ILIT, make sure that you consult with your insurance agent, financial planner, and legal and tax advisers to ensure that this is the right course of action for you and to minimize potential adverse consequences.

Answers to our readers' questions were provided by Lawrence B. Keller, CFP, CJU, ChFC, founder of Physician Financial Services in Woodbury, New York, and Michael J. Hausman, JD, partner with the law firm Karol Hausman & Sosnik P.C. in Garden City, New York. Send your money management questions to medec@advanstar.com
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