Serving as trustee of an Irrevocable Life Insurance Trust (ILIT) comes with strict fiduciary duties. Chief among them is the obligation to act solely in the best interests of the trust’s beneficiaries. When trustees engage in self-dealing—directly or indirectly benefiting themselves through trust transactions—they risk breaching this duty and exposing both the trust and themselves to legal and financial consequences.
For ILIT trustees, the risk of self-dealing often arises in subtle ways. Understanding how it occurs,and how to prevent it,is essential to fulfilling fiduciary obligations.
What Is Self-Dealing?
Self-dealing occurs when a trustee puts personal gain ahead of the interests of the trust. Examples include:
- Purchasing trust assets for less than fair market value
- Selling personal assets to the trust
- Using trust funds or policies for personal benefit
- Favoring themselves or related parties in investment or policy decisions
Even when well-intentioned, these actions can violate the duty of loyalty, which requires trustees to avoid conflicts of interest and act exclusively for the beneficiaries’ benefit.
Read More: The Many Duties and Responsibilities of a TOLI Trustee
ILIT-Specific Self-Dealing Risks
ILITs present unique risks for self-dealing because of the assets they hold and the transactions required to maintain them. Trustees should pay special attention to:
1. Policy Replacements
When replacing an existing policy, trustees must carefully evaluate whether the change benefits the trust—not an advisor, grantor, or the trustee themselves. Failure to document the rationale may create the appearance of self-dealing.
2. Premium Financing Arrangements
Some ILITs use loans or sophisticated funding strategies to cover premiums. If a trustee or related party benefits from these arrangements, it can create conflicts of interest.
3. Life Settlements
Selling a policy in the secondary market can be a prudent option, but trustees must ensure the sale is at fair market value and not structured to benefit insiders at the trust’s expense.
4. Investment of Cash Assets
If a trust holds significant cash (e.g., from gifts not yet used for premiums), the trustee must ensure investments are prudent and not tied to personal or affiliated business interests.
Read More: The Risks of Naming an Individual Trustee
Consequences of Self-Dealing
Self-dealing is one of the most serious breaches of fiduciary duty. Courts often apply a strict standard, where even the appearance of impropriety can be enough to impose liability. Consequences may include:
- Personal liability for losses to the trust
- Reversal of improper transactions
- Legal costs and reputational harm
- Removal as trustee
For corporate trustees, reputational damage can also impact client relationships and regulatory standing. Increasing regulatory scrutiny has raised the bar for fiduciary oversight and transparency.
Best Practices to Avoid Self-Dealing
Trustees can take several proactive steps to reduce the risk of self-dealing:
- Maintain Independence: Avoid transactions where personal interests could conflict with fiduciary duties.
- Document Decisions: Record the rationale for major actions, especially policy changes or funding strategies.
- Seek Independent Valuations: Use outside experts to determine fair market value for policy sales or other transactions.
- Consult Legal Counsel: When in doubt, seek legal advice before proceeding with transactions that may present conflicts.
- Communicate with Beneficiaries: Transparency builds trust and reduces the likelihood of disputes.
The Role of a Corporate Trustee
One of the strongest protections against self-dealing is the appointment of an independent corporate trustee. Unlike individual trustees, corporate fiduciaries are bound by strict internal policies, regulatory oversight, and established processes designed to avoid conflicts of interest.
Self-dealing is a serious risk for ILIT trustees, with consequences that extend far beyond individual transactions. By staying vigilant, documenting decisions, and leveraging independent oversight, trustees can fulfill their fiduciary duties while protecting both the trust and themselves from liability.
At LITCO, we combine industry expertise with a fiduciary-first approach, ensuring ILITs are administered without bias, conflicts, or undue risk. To learn more about our successor trustee services, request a consultation.
