I make sure to tell my clients that in order to qualify the premium payments as “gift tax free” a certain procedure should be followed. The Trustee of the ILIT should have a tax identification number and then create a checking account. This should be done with plenty of time (at least 45 days) prior to the date the annual premium is due. Next, the Trustee should send out the Crummey Letters to the beneficiaries of the ILIT. This advises the beneficiaries of the contribution to the ILIT and informing them that they have a certain time period under the terms of the ILIT where they can withdraw the funds which are attributed to their shares.
A Crummey letter is really the name for a physical letter that is sent to the beneficiaries of an irrevocable life insurance trust informing them of a gift to the trust and their right to withdraw their share of the gift. The Crummey letter is created to change a future gift into a present gift by allowing the beneficiaries the right to withdraw the funds for a certain period of time. Now the beneficiaries could actually use their right to withdraw the contribution, but if they do, the insurance policy may lapse because it is not paid. Most Grantors who create irrevocable life insurance trusts are hoping the beneficiaries don’t withdraw their share of the contribution, since the amounts of the Crummey withdrawal would be theoretically small compared to the amounts they would receive under the ILIT. Ordinarily, the gift should be made more than 45 days in advance of the premium payment which allows for enough time to send out and receive the Crummey letters and to allow for the beneficiary’s right to withdraw to come to an end. In order to make a gift to a trust qualify as a present interest gift- the beneficiary must be given the right to withdraw the funds which are transferred for a certain period of time after the gift is made. The right to withdraw the funds is referred to as a Crummey Withdrawal. The beneficiaries of the ILIT must be notified of their right to withdraw each time a transfer is made to the trust in order for the transfer to qualify as an annual exclusion gift. So, when a Trustor makes a gift to a trust which indirectly benefits someone in the future they are not considered to have a present interest in the gift to the trust because they do not have immediate use of that gift. In order for a gift to meet a present interest requirement many trusts give a limited right of withdrawal to each beneficiary, which evidences to the IRS that the gift to the trust does qualify as a gift of a present interest. The Trustor cannot write a check directly to the insurance company because if the Trustee never holds the funds and does not have the opportunity to give the beneficiaries of the ILIT the advance notice before paying the life insurance premium there cannot be a present interest to the beneficiaries. The Trustor should, therefore, write a check to the Trustee of the ILIT from a non-interest bearing Trust checking account.
Finally, I strongly urge my clients that the amount that is gifted to the irrevocable trust never exactly match the amount of the premium payment, which further strengthens the potential argument of the Trustee’s absolute ability to decide how to handle the gifts to the trust. The process of making the gift correctly, documenting and memorializing the notices to the beneficiaries and allowing for the gift waiver period is imperative to the IRS acceptance of the present interest argument.
* A sample of a Crummey letter used in 2014 is attached for reference.