Is Your ILIT A Ticking Time Bomb?
Is your Irrevocable Life Insurance Trust ("ILIT") funded by a universal life policy more than five years old?
If so, your ILIT could go from a safe vehicle to leverage and shift wealth on a potentially estate and income tax free basis to a ticking time bomb that may implode when you need it the most. If your ILIT holds a universal life policy, now is a good time to dust off the policy and ask the carrier for a new illustration based on current assumptions.
Here's why. Universal life policies are interest sensitive products, which means the illustrations the carrier gave when the policy was taken out were based on the prevailing interest rate environment at that time. In the early years of a universal life policy, the actual cost of insurance is for far less than the premium and the insurance company invests the difference. The insurance company is betting it can make enough in the early years of the policy so that it can make up for the increased cost of insurance in the later years of the policy.
If the investment does not perform as the illustration shows, i.e. the internal rate of return on the investment is less than projected, the policy will terminate unless the owner infuses additional cash. If your universal life policy is older than five years, the interest rate assumptions contained in the illustration given when the policy was issued are probably unrealistically high, which means your policy is on a road to self-destruction.
A careful review of the illustration may show when the policy will implode due to these increased costs. But remember, that implosion date was determined based on the interest rate environment at the time the policy was issued. If the insurance company's return on investment is less than expected, the implosion will happened sooner, not later.
The good news is that in most cases the ticking time bomb can be diffused, sometimes on a tax neutral basis. It all starts with requesting a new illustration based on current assumptions, which the insurance company must provide upon request free of charge at least once a year. The new illustration based on current assumptions will show the new implosion date (date the policy lapses based on current assumptions).
With this information, you may be able to diffuse your bomb before it goes off and leaves nothing behind.
