Universal Life Policy With Indemnity

Universal Life Policy With Indemnity LTC Rider Owned By An ILIT

The use of an Indemnity LTC Rider is crucial to keep the life insurance death benefit estate tax free. That’s because any rider benefits will be paid only to the ILIT as policy owner, and NOT used to pay extended care costs directly to the extended care provider. Since LTC benefit claims are paid only to the ILIT, this Indemnity LTC Rider does NOT create an incident of ownership in the UL policy. Any incidents of ownership in a life insurance policy causes the life insurance death proceeds to be included in the gross estate of the insured estate owner.

This important Indemnity LTC Rider contrasts with the so-called reimbursement style LTC riders. Reimbursement type of LTC riders pay extended care benefit payments directly to the provider on behalf of the insured. Most advanced planning commentators take the position that this reimbursement type of LTC rider on a UL policy owned by an ILIT is considered an incident of ownership for estate tax purposes that causes the life insurance death proceeds to be included in the gross estate of the insured.

Note: The tax reform proposals of President Trump include the repeal of federal estate taxes. ILITs may still be useful planning tools even if federal estate taxes are eliminated.


Client Profile:

Successful business owners, professionals, and wealthy individuals who have gross estates large enough to be exposed to:

  • Federal estate taxes (assuming some form of federal taxes exist at death)
  • State death taxes (assuming state taxes are levied in state of residence)
  • Income in respect of decedent (IRD) income taxes on their QRP/IRA assets.


Key Phrases to Use with Your Client:

  • Income and estate tax-free death benefit to offset estate and income taxes due at your death.
  • Special indemnity Long Term Care rider that provides tax free restoration of personal funds used to pay extended care expenses.
  • A guaranteed no-lapse Universal Life policy with an extremely competitive Internal Rate of Return (IRR) out to life expectancy and beyond.
  • Low present value cost provides protection against death and extended care expenses in the same product package.


Planning Options Available When Indemnity LTC Rider Benefits are Paid to an ILIT

Assuming that a no-lapse UL policy with an indemnity LTC rider is owned by an ILIT, here are some planning options available to the insured and family to either offset or pay for any extended care medical costs:


Option #1: Carrier makes income tax free LTC claim payments to the ILIT. ILIT keeps cash in the ILIT to be invested in a side fund.

  • ILIT keeps LTC claim payments in the trust and invests in stock, bonds, mutual funds etc.
  • This trust owned portfolio of financial assets is estate tax free.
    • Offsets extended care LTC costs paid out of pocket by the estate owner.
  • The estate owner pays any LTC care costs out of pocket from other personal assets.
    • These LTC medical service payments reduce the gross estate for estate tax purposes by the amount of these out of pocket payments.
  • At death, the life insurance proceeds paid to the ILIT from the base UL policy are income and estate tax free.


Option #2: Carrier makes income tax free LTC claim payments to the ILIT. ILIT loans cash to insured estate owner.

  • ILIT makes a private loan to the estate owner.
    • An interest only note payable at the current AFR rate is executed between the trust and the estate owner.
  • The estate owner uses the cash received from the loan to pay extended care LTC expenses.
  • The estate owner makes annual interest payments on the note to the ILIT from other personal resources.
  • At death, the estate of the deceased pays off the loan principal on the note to the ILIT from other estate assets and takes an estate tax deduction for debts paid from the estate on Line 2 of the Form 706 U.S. Estate Tax return [IRC Section 2053(a)].
  • At death, the life insurance proceeds paid to the ILIT from the UL base policy are income and estate tax free.


Option #3: Carrier makes income tax free LTC claim payments to the ILIT. ILIT distributes cash to ILIT beneficiary (adult child).

  • ILIT trustee uses discretionary authority granted in a well-drafted trust document to make distributions of trust principal to any one or more of the trust beneficiaries (adult children of insured estate owner)
  • This cash distribution is a tax free distribution of trust principal to the adult child.
    • The character of the income (tax free LTC benefits) retains its character when distributed to trust beneficiaries.
  • The adult child voluntarily (under no obligation) makes an unlimited gift tax exclusion gift of this cash on behalf of the parent to pay the LTC medical expenses of the parent under IRC Section 2503(e).
  • At death, the life insurance proceeds paid to the ILIT from the UL base policy are income and estate tax free.


The indemnity type of LTC rider may either be a qualified LTC rider under IRC Sec 7702B, or an accelerated death benefit rider for chronic illness under IRC Section 101(g).
Both types of indemnity riders pay income tax free benefit claim payments to the policy owner when triggered. Any tax free benefits paid under both types of riders reduces the life insurance death benefit dollar for dollar.


What type of protection product will match your client’s needs?

  1. A stand-alone annual premium traditional LTC product
  2. A linked-benefit single premium life insurance-LTC product
  3. An annual premium no-lapse UL life policy with a reimbursement type of LTC rider
    or
  4. An annual premium no-lapse UL policy with an indemnity type of LTC rider.

ilit-ul-policy-with-indemnity-ltc-rider-chart

Contact Joe Savastano for your client’s needs.

Russell E. Towers   JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group
russ@bsmg.net