Avoiding Inadvertent Taxable Gifts: Crummey Powers and ILIT Trustee Responsibilities
Lindsey M. Bessy, ALMI, CLTC, MBA, CLU, CASL- Financial Representative
Many individuals follow an annual gifting strategy that involves making gifts to trusts, including Irrevocable Life Insurance Trusts (ILITs), and rely on beneficiary withdrawal powers to avoid taxable gifts by qualifying the transfers as annual exclusion gifts.
For gifts to trusts to qualify for the annual gift tax exclusion, the beneficiaries must have a present interest in the gift. Properly structured and administered “Crummey” withdrawal powers can satisfy the present interest, but they also must comply with several requirements to reduce the risk of unintended taxable gifts (by either the grantor or the power holder) and IRS scrutiny.
For example, so called “hanging” Crummey powers can avoid inadvertent gifts by a beneficiary who failed to exercise his withdrawal rights, but may increase the amount subject to the beneficiary’s withdrawal power or result in inclusion of that amount in his or her estate. Ideally, beneficiaries should have actual notice of their Crummey withdrawal powers and a reasonable opportunity to exercise it within 30 to 60 days.
The IRS continues to review trust contributions and their qualifications as annual gift tax exclusions. Failure to comply could result in adverse gift tax consequences to the donor and/or beneficiaries.
Achieving a favorable outcome on annual exclusion issues may require extensive litigation if the IRS questions the trust administration; therefore, the conservative approach for making annual exclusion gifts to a trust will follow best practice with a guard to structuring and providing notice of Crummey powers to trust beneficiaries.
With changing economic conditions and life insurance products, the administration of an ILIT becomes complicated. Because of this, fewer financial institutions are willing to act as ILIT trustees, and in turn, clients are relying on friends and family with no to minimal experience in trust administration, knowledge of life insurance or awareness of the consequences of their actions or inactions.
Below are EBN’s suggestions for success as an ILIT Trustee, whether it is for an individual or a financial institution:
- Review the entire trust document to familiarize yourself with your duties and determine what authority you do and do not have.
- Remember the various duties owed to the beneficiaries – the duty of loyalty, the duty to invest prudently, and the duty to act in good faith and in accordance with the terms of the trust and in the best interest of the beneficiaries.
- Mitigate any exposure to liability for breach of trust.
- Maintain records of reviews, actions, deliberations, reasoning for taking such action and any communication to beneficiaries.
- Perform due diligence reviews of the portfolio (i.e. insurance) with outside advisors to assist with managing the trust assets—this includes determining adequate funding levels and future illustrated performance of the existing policies.
Bottom Line: With the duration of low interest rates, changing economic conditions and complexity of insurance products, it is increasingly important for trustees to be proactive in managing the trust assets/insurance policies to avoid any potential liability.
Advisors may want to take this opportunity to contact donors and trustees who recently made or received annual exclusion gifts to review these Crummey power requirements, confirm past and future compliance, and to suggest corrective measures if needed.
CONTACT EBN for more information on this topic.