The Irrevocable Life Insurance Trust and its Use by Physicians

In an era where high cash value (HCV) life insurance policies can be used as cash alternatives it's important for doctors to consider the use of an Irrevocable Life Insurance Trust or ILIT.

We've previously provided an introduction to ILITs and how doctors can use them for estate tax avoidance and asset protection of both the cash value and death benefit of life insurance policies. For many physicians, life insurance polices may be both a significant investment in terms of the premium you commit to and a significant asset for the family of the insured person. Another key factor to consider is the liquidity options that your ILIT may or not present; they are not all drafted the same way.

Ideally the ILIT will be drafted in a way that allows access to the cash value of the policy through one of several means, including policy loans, and in some cases, a private split dollar agreement that allows the trust to repay the premium to the person who paid or their estate at death or sooner at the discretion of the Trustee, the person appointed to mange the trust.

From a macro view, it's really pretty simple:

1. A written loan agreement is created and approved by the trustee (TTE). This agreement includes the terms of the loan and specifies a commercially reasonable rate of interest that is at or above what the policy is making to justify the loan and to document legitimate business purpose on the part of the trust/TTE. So for instance, if the loan costs the trust 75 basis points (.75 percent) in interest, the borrower should pay the trust an amount above that to create a reasonable economic benefit for the trust and its beneficiaries, say 125 basis points (1.25 percent). Considering that the average bank is paying 30 basis points or less on your cash, a 50 basis point gain may be a good deal for both the trust and the borrower.

2. The agreement is formalized by both parties, the Trustee and the Borrower;

3. The trust can retain a security or collateral interest in a variety of other assets including the subject loan, including for instance, in real estate that the loan may be used to acquire. This creates collateral protection for the trust and asset protection for the asset itself, as there is a first position secured creditor of record, the trust itself.

4. If the policy requires additional premium or funding from assets that have been contributed to the trust, the loan agreement should specify events that would allow discretionary acceleration of the loan to protect the policy.

5. In some cases the policy will be fully funded, so make sure you have a very specific illustration of how such a loan, if not repaid, would affect both the death benefit and longevity of your policy.

Of course, if your policy has no cash value, either because it is term insurance or because you need to fund it for a number of years before that cash value exists, the loan issue is moot, but the ILIT may still be valuable tool for the reasons enumerated above and in the previous articles at the links provided. Ask your advisers if they have considered this issue and how it was determined (or if) that you did or did not need the ILIT in your subjective insurance fact pattern. If you don't yet have the policy or are finally buying more insurance for yourself or the spouse you’ve left underinsured for too long, consider the important life insurance buying questions we've discussed before in detail; there are as many options in insurance as there in investment options these days. Caveat Emptor.