The use of an Irrevocable Life Insurance Trust (ILIT) may also be appropriate when the purpose for purchasing the life insurance policy is to create liquidity for the estate of the insured person. To avoid this potential tax trap, it is prudent to have the policy owner also be the beneficiary whenever someone other than the insured owns the policy. This situation can create possible adverse estate tax consequences for Party #1. #UNHOLY TRINITY CODE#Why is this a problem? If Party #1 has purchased a $1 million life insurance policy covering Party #2’s life and names Party #3 as beneficiary, at Party #2’s death, the Internal Revenue Code deems this event as Party #1 having made a taxable gift of $1 million to Party #3. The “unholy trinity” arises when all three of these parties are different people. Party #2 is the person whose life is being insured and Party #3 is the beneficiary (ies) who receives the death benefit upon the passing of Party #2. They are: (1) the right to name or change the beneficiary, (2) the right to cash in, surrender or cancel a policy, (3) the right to receive policy dividends, if any, (4) the right to borrow against policy cash value, (5) the right to pledge the policy as collateral for a loan, and (6) the right to assign any rights and/or the policy itself and the right to revoke such assignments. Party #1 is the owner of the insurance policy and this person has numerous rights. In addition to the insurance company, there are three named parties in the insurance contract. The “unholy trinity” is an insurance industry euphemism that describes a problematic circumstance with a life insurance contract.
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