Everybody knows we should do this, but nobody does it. In order for an insurance policy to be estate and income tax-free it must be placed inside an irrevocable life insurance trust, know as an ILIT. If the IRS does an audit, and no crummey letters have been sent and signed and returned by the named beneficiaries (every year), they could undo the trust and bring it back to the estate for estate tax purposes. The policy would still be income tax-free-but the face value of the policy is now included in the estate.
Crummey trust is the power of appointment given to the trust. A separate account is established for the trust. Each person writes a check from this trust for the other’s insurance premium, or if they utilize an outside trust service to provide the premium and crummey letters on their behalf. You cannot have any incidence of ownership (you or your spouse) on the insurance policy; the trust is named the beneficiary (not the estate). The Crummey trust allows additions to the trust, under the gift tax exclusion, up to the number of named beneficiaries. Every year, a letter must be sent to each beneficiary giving him or her the right to withdraw cash from the trust. If a person withdraws the cash, the withdrawal may undo the trust.
Sample crummey letter: (to each beneficiary)
SPECIMEN “CRUMMEY” NOTICE LETTER
Dear Trust Beneficiary:
Please be advised that a gift has been made to the ____________________ Irrevocable Trust on ___________ day of _____________, 19_____. As a beneficiary of the trust, pursuant to the provisions of Article III, you have the present right to demand from the trust your pro-rata portion of the gift, in the amount of $_________. If you wish to exercise your right of withdrawal, please do so in writing, addressed to the undersigned, within 30 days of receipt of this letter. If you do not wish to exercise your right of withdrawal within this time period, your right to withdraw will expire.
If you do not wish to withdraw from this trust, please sign and date the waiver below and return it to me.
Beneficiary Waiver of Withdrawal I acknowledge receipt of the notice of withdrawal for the ________________ Irrevocable Trust and hereby relinquish irrevocably such withdrawal right as of the date indicated below.
Date Trust Beneficiary
*This sample document is prepared for purposes of illustration and is not intended as legal advice. The actual document which is to be executed by the recipient must be drawn by the recipient’s own attorney.