Purchasing vs. Gifting a Policy: The 3-Year Rule

The IRS’s three-year look-back policy, commonly known as the three-year rule, poses a significant challenge for those looking to transfer existing life insurance policies to an Irrevocable Life Insurance Trust (ILIT). Under this rule, if an insured individual transfers a policy to an ILIT and passes away within three years of the transfer, the entire policy proceeds are included in the insured’s gross estate. While establishing a trust with a new policy circumvents this issue, it may not always be feasible if there is an existing policy. We’ll explore the benefits of purchasing vs. gifting a policy into the trust.

Avoiding the 3-Year-Rule with a New Policy

To avoid the three-year rule, the best practice is for the trustee to apply for a new life insurance policy to be issued and owned by the trust when it is opened. This ensures that the policy remains outside the insured’s estate, even if the grantor passes away within three years.

Once the trust is established, the grantor should initiate a transfer of cash to be used to pay the initial premium. The trustee should then apply for the new life insurance policy, with the trust as the original applicant and owner. It is imperative that the insured/grantor not have any possession of the policy at any time to avoid the lookback period. Upon the insured’s death, the proceeds are payable to the trust, providing liquidity for estate tax liabilities.

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Trust & Investments

Purchasing vs. Gifting a Policy: The 3-Year Rule

Avoiding the 3-Year-Rule with a New Policy

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