Robert Bloink, JD, LLM and William H. Byrnes, JD, LLM

Flexibility is not a dominant selling point of Irrevocable Life Insurance Trusts (ILITs)—or the life insurance policies that inhabit them. ILITs usually serve a single purpose, for instance providing a liquid fund to pay estate taxes, but a little creativity and flexibility can go a long way with clients who are on the fence. A recent IRS ruling (Rev. Rul. 2011-28, 2011-49 IRB 830) provides a path for at least one type of ILIT flexibility.

Substitution Power

There are not a lot of places to work flexibility into the structure of an irrevocable trust; too much flexibility and the value of the trust’s assets will be included in the grantor’s estate. But one area where flexibility can be introduced is in a power of substitution retained by the grantor.

In Revenue Ruling 2008-22, the IRS came to the general conclusion that a grantor’s substitution power will not cause trust assets to be included in the grantor’s estate. Rev. Rul. 2011-28 extends Rev. Rul. 2008-22 to include a substitution power over a life insurance policy held in an irrevocable life insurance trust.

Conditions on Substitution

In both Rev. Rul. 2011-28 and 2008-22, the non-inclusion rule is subject to two conditions:

1. The trustee must have a fiduciary obligation to determine that the property acquired by the grantor and the substituted property are actually equivalent in value.
2. The grantor’s “substitution power cannot be exercised in a manner that can shift benefits among the trust beneficiaries.”

The Ruling clears a path for replacing policies in an ILIT without disturbing your client’s estate plan. Outdated, expensive policies no longer have to be an expensive irrevocable mistake. You have an opportunity to put the right policy in place for your client, even where their policy is locked up in an ILIT.

Go to Advisor’s Journal for a complete discussion regarding ILIT replacement policies.

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