I created an Irrevocable Life Insurance Trust several years ago, naming my then-wife as the beneficiary. We are now in the process of getting divorced, and I want to change the beneficiary to remove her. What are my options for changing the trust?
An irrevocable life-insurance trust is a common form of estate planning. When used properly, it can help remove the proceeds of an insurance policy from one’s gross taxable estate at death. When the federal tax exemption was only $1 million, or even when it was raised to $5 million, this was helpful for some individuals who had many millions in term-life insurance or whole-life insurance, which placed their taxable estate in excess of the estate-tax exemption. It is also helpful to ensure that these large, liquid sums were used for the purpose intended, rather than going directly to the named beneficiary outright, without restrictions on the use of the funds.
As the name indicates, an irrevocable life insurance trust’s terms cannot be amended after it is created. Maybe, as in this case, the grantor no longer wishes to provide for one or more of the beneficiaries of the trust, or wants to change its dispositive terms. In the State of New York, “irrevocable,” means that it is “less flexible,” since even irrevocable trusts can be modified or amended in accordance with the statutory law if, and only if, all of the interested parties (beneficiaries, the grantor, and the Trustees) agree in writing to the modification. If any of those interested parties will not agree to the proposed modification, or if any of them are not adults of majority age, amendment by agreement may not be possible.
What then are the options for adjusting this trust after a change in circumstances? What is a grantor to do if she is no longer happy with the terms of her trust?
A grantor can always stop making gifts to the trust, let the existing policy lapse, and start over with a new trust and a new policy. But, retaining the current policy may be preferable for health or economic reasons. The irrevocable life-insurance trust can sell the policy back to the grantor-insured, who then assigns it to a new irrevocable life-insurance trust, but that will start the running of a new three-year rule (under IRC Section 2035(a)). If the trust permits, the policy can be distributed to one or more of the beneficiaries. But, absent a trust, the policy beneficiaries would not be protected from creditors, ex-spouses, or estate taxes. Here are a few options:
Based on IRS Revenue Rulings (Rev. Rul. 2007–13), a grantor of an existing irrevocable life-insurance trust can create a new one with the new desired beneficiaries and provisions, and then gift or loan the new trust with sufficient assets to enable the new trust to buy the policy from the old one. However, there are various precautions that will need to be followed in order to engage in such a transaction properly and avoid scrutiny from the taxing authorities. It is also critical to avoid future claims by the affected beneficiaries against the grantor’s estate or the Trustees. There are many tax and non-tax issues specific to each person’s situation that must be examined carefully before embarking on a change to any trust, particularly an irrevocable life-insurance trust. Trustees and grantors should proceed with caution and with legal advice before engaging in this type of transaction.
Alison Arden Besunder is the founding attorney of the law firm of Arden Besunder P.C., where she assists new and not-so-new parents with their estate-planning needs. Her firm assists clients in Manhattan, Brooklyn, Queens, Nassau, and Suffolk Counties. You can find Alison Besunder on Twitter @estatetrustplan and on her website at www.besun