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An irrevocable life insurance trust (ILIT) is a specific type of trust that holds a life insurance policy outside your taxable estate. This setup protects the policy’s value from being subject to estate taxes upon your death. You make annual gifts to the trust to fund the ILIT. The IRS sets a yearly gift limit, but as long as your gifts don’t exceed that limit, they won’t trigger gift taxes.

Trustees must send Crummey letters to the trust’s beneficiaries to make ILIT gifts qualify as tax-free. These letters grant each beneficiary the right to withdraw the gift for a limited period. This step turns the gift into a “present interest,” which the IRS requires to avoid gift tax. Good ILIT administration includes sending timely Crummey notices and tracking each gift to ensure compliance with the law.

If you have questions about ILIT administration or need assistance with Crummey letters and annual gifting rules, Pennington Law, PLLC can help. Contact us today to schedule your complimentary initial consultation.

Annual Gifting Rules for ILITs

The IRS sets annual gifting rules that limit how much money or property you can give to someone without tax consequences. This is referred to as the annual gift tax exclusion. You can give this amount to as many people as you want each year. As long as each gift stays under the annual limit, you don’t have to file a gift tax return or use any of your lifetime exemptions.

Some gifts do not count toward the gift tax, even if they exceed the limit. For example, if you pay for someone’s tuition or medical bills by sending money directly to their school or provider, you don’t have to report the gift. These payments don’t reduce your annual exclusion or lifetime limit.

When you fund an ILIT, you are effectively making gifts to the trust. The trust uses those gifts to pay for life insurance premiums. The trustee must send Crummey letters so the gifts qualify for tax-free treatment. These letters grant each beneficiary the right to withdraw the gift for a limited time, which renders the gift a “present interest” under IRS rules.

Administration of Crummey Letters

Trustees send Crummey notices to beneficiaries to inform them of new gifts made to an ILIT. These letters notify beneficiaries that they have the right to withdraw money from the ILIT. This right, known as a Crummey power, enables the gift to qualify for the annual gift tax exclusion. The IRS only allows this exclusion if the gift counts as a “present interest,” and Crummey power provisions make that possible.

Crummey powers are subject to the so-called “five or five” rule. This rule limits a beneficiary’s power to withdraw trust assets in a way that avoids gift tax consequences. Specifically, the IRS allows a withdrawal right up to $5,000 or five percent of the trust’s value, whichever is greater. As long as withdrawals do not exceed this threshold, they are not treated as taxable gifts.

When you receive a Crummey letter, you usually have 30 days to withdraw the gift if you choose to do so. Most people don’t take the money because leaving it in the trust allows the ILIT to pay insurance premiums and protect the full value of the life insurance benefit. Over the long term, this typically provides beneficiaries with more financial value than taking out smaller gifts in the short term.

If you have already received a Crummey letter in the past, you can expect to get a new one every year the trust receives a gift. Crummey notices are a crucial component of ILIT administration. Trustees must follow the following rules to keep ILITs valid and maintain their tax advantages:

  • The trust must be irrevocable, meaning its creator cannot modify it after it is established.
  • Gifts must go directly to the trust.
  • Each beneficiary must receive written notice of their withdrawal rights.
  • Beneficiaries must have a real chance to withdraw and enough time to do so.

Best Practices for ILIT Administration

If you are a trustee responsible for administering an ILIT, you must take certain steps to keep the trust running properly. First, you should keep the trust’s bank account separate from all other accounts. Mixing funds could cause legal trouble and weaken the trust’s protections. You’ll also need to track all gifts made to the trust and keep detailed records of the specific dates and amounts.

Every time the trust receives a gift, you must send Crummey letters to each beneficiary. These letters should explain the beneficiaries’ withdrawal rights and give them at least 30 days to respond. You should also keep proof of each notice sent out on time for your records.

Finally, you must manage the life insurance policy carefully. That includes paying premiums on time, updating your contact information with the insurance company, and reviewing the policy term annually. You can better protect yourself and the trust’s tax status if you follow these steps and keep clean records.

The ILIT Administration Process in Arizona

In Arizona, ILIT administration follows general trust principles set out in the Arizona Trust Code. For example, trustees must act in good faith and in the best interests of the beneficiaries. Trustees should keep track of all insurance policy changes, premium payments, and beneficiary designations. They must also keep clear records and follow the terms of the trust.

When someone funds an ILIT, the trustee must deposit the money into the trust’s separate account and send Crummey letters to beneficiaries. This step protects the gift from incurring federal gift tax. Arizona does not impose a state-level gift tax, but trustees still need to follow federal rules, including proper notice and use of Crummey powers.

Contact Our Firm for a Complimentary Consultation

If you need help managing Crummey notices, tracking annual gifts, or keeping your ILIT in good standing, Pennington Law, PLLC can help. Contact our legal team today to arrange your free initial consultation and receive personalized support tailored to your estate planning goals.