As pointed out in other columns in this newsletter, President Obama’s holiday gift to affluent families in the form of new tax legislation known as The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, significantly expanded the number of families who will escape the grasp of the federal estate tax system. Married couples who have not made any prior taxable gifts can now pass the first $10,000,000 of their wealth tax free to their children without incurring a federal estate tax. For tax years before 2010, many Florida residents used life insurance trusts to help pay the federal estate taxes. This may still be the case after 2010 even with a much higher exemption. The typical arrangement was to create an irrevocable life insurance trust (“ILIT”). This is a trust which established a property interest in a life insurance contract to a person (the trustee) at the request of the person creating the ILIT (the grantor and generally the insured) for the benefit of a third party (the beneficiary). The trustee of the ILIT held the insurance policy as a trust asset and would receive the insurance proceeds upon the grantor’s death. In some cases an ILIT held an insurance policy on the lives of more than one grantor-insured, such as in the case of a husband and wife. Without the ILIT the insurance proceeds would generally pass to the beneficiaries free from federal income taxes but might still be subject to federal estate taxes in years other than 2010. The trustee of the ILIT would be responsible for managing the ILIT and monitoring the insurance policy for the benefit of the beneficiaries. But what if the policy did not perform the way it was originally intended and the proceeds were less than expected by the beneficiaries and the grantor?

Florida law imposes a duty on the ILIT trustee for the complete responsibility to determine the quality and appropriateness of the life insurance policy, as well as to monitor the policy to ensure that it is and remains an appropriate trust investment. This is part of the Florida Prudent Investor Rule. In our changing times of failing insurance companies and the fact that many insurance policies were sold assuming an illustrated rate of return which is not available today, the trustee may not be in a position to reckon with these duties. This is especially disconcerting when the grantor usually has applied for the purchase of the insurance (thus choosing the insurance company and the type of insurance), named the beneficiaries and is the only source of funds with which to pay the premiums for the insurance. These decisions are usually made before the trustee actually takes office and thus without his or her knowledge.

In addition to the Prudent Investor Rule concerns, the ILIT must have an “insurable interest” in the life of the insured. This requires investigation. Generally this means that a person cannot purchase a life insurance policy on someone else if the other person’s death will only have the effect of causing a benefit payable to the policyholder. If an insurable interest does not exist at the time of purchase of the policy, the proceeds may not be legally payable to the ILIT, which would eliminate the beneficiary’s anticipated financial benefit and thus create the potential for litigation.

Florida has reacted to this by enacting new legislation which took effect July 1, 2010. This legislation insulates a trustee from liabilities arising in connection with the trustee’s duty to comply with the Florida Prudent Investor Rule with respect to the life insurance contracts and to determine whether a policy was procured in violation of Florida’s “insurable interest” requirement. If you will be or are the trustee of an ILIT, you should seriously consider taking advantage of Florida’s new statutory protection and seek advice. Unless the ILIT language opts out of the new legislation, the new law eliminates the above potential liabilities by providing that the trustee will be under no duty to:

1. Determine whether the ILIT has an insurable interest in the insured;
2. Determine whether the policy is, or remains, a proper investment of the ILIT;
3. Investigate the financial strength of the life insurance company issuing the policy;
4. Determine whether to exercise any policy option available under the policy;
5. Diversify any life insurance policies or other assets of the ILIT with respect to the policy;
6. Inquire about or investigate the health or financial condition of any insured.

But note that these protections are not automatic and are subject to certain limitations. The ILIT must either (i) expressly make the new legislation applicable to life insurance policies owned by the trust or (ii) the trustee must give beneficiaries advance written notice that the new law will apply. The beneficiaries will have 30 days upon receipt of the notice to object; otherwise the new law will automatically apply at the end of the 30-day period.

We are urging all of our clients who have established Florida life insurance trusts and their respective trustee(s) to discuss this new statute with your counsel at Smith, Gambrell and Russell.