As a financial advisor or estate planning attorney, you’ve likely encountered clients who have named a family member or friend as trustee of their Irrevocable Life Insurance Trust (ILIT). While this might seem like a convenient choice, serving as an ILIT trustee comes with significant responsibilities. If your clients are using an individual trustee for their ILIT, it’s important to ensure they understand the potential risks of their choice.
The Risks of an Individual ILIT Trustee
Managing trust-owned life insurance (TOLI) is becoming increasingly complex. Based on data from our affiliate ITM’s portfolio of over 25,000 policies, the challenges have only grown in recent years:
- 46.5% of all policies are now projected to lapse prior to maturity—a significant increase from 27.7% in 2022.
- 32.5% of policies will lapse before life expectancy, a dramatic rise from just 11% previously.
- 49.1% of no-lapse guarantee provisions have been compromised, up from 30%, meaning many policies are no longer as secure as originally intended.
Given these complexities, an individual trustee may struggle to manage an ILIT effectively. Here are some of the key challenges and risks individual trustees may face:
Lack of Life Insurance Expertise: TOLI requires specialized knowledge of insurance policies, premium structures, and ongoing policy performance. With nearly one-third of policies now expected to lapse before life expectancy, trustees must actively manage and monitor policies to prevent significant financial losses.
Conflicts of Interest and Lack of Continuity: Individual trustees, especially family members, may struggle to remain impartial. Additionally, if the trustee resigns, becomes incapacitated, or passes away before the trust funds, the ILIT could face unnecessary disruptions. Given that the average trustee term now spans over three decades, long-term stability is a critical factor to consider.
Personal Liability for Policy Mismanagement: A trustee who fails to review policy performance, address rising loan risks, or maintain compliance with trust provisions could be held personally liable for financial losses. With loan issues increasing by 60%, an uninformed trustee could inadvertently trigger taxable events, putting beneficiaries at risk.
The Administrative Burden: Trust administration is highly detailed and time-consuming. From issuing Crummey notices to coordinating policy reviews, a trustee must stay engaged for the long haul. With the rising complexity of life insurance policies, staying on top of administrative duties is more challenging than ever.
Learn More: The Key Responsibilities of a TOLI Trustee
Tax and Compliance Risks: Mismanagement of an ILIT can lead to unintended tax consequences, including gift tax issues, estate tax inclusion, or IRS audits. With nearly half of no-lapse guarantees compromised, policies that were once deemed low-risk now require heightened oversight to ensure they meet trust objectives.
Should a Professional Trustee Serve as ILIT Trustee?
Some grantors turn to their financial advisor or estate planning attorney to serve as trustee, believing it to be a better alternative than a family member or friend. While a professional trustee offers certain advantages, there are also challenges to consider.
Benefits of a Professional Trustee
Higher Level of Expertise: Compared to a family member or friend, a professional trustee has more financial and legal knowledge, making them better equipped to manage trust assets effectively.
Fewer Conflicts of Interest: A professional trustee is more likely to make impartial, conflict-free decisions regarding the ILIT than a friend or family member.
Drawbacks of a Professional Trustee
Time-Consuming Responsibilities: Given the complexity of TOLI today—especially with nearly half of policies now at risk of lapsing—this role demands continuous oversight, taking valuable time away from the professional’s core business.
Learn More: The Many Duties & Responsibilities of an ILIT Trustee
Potential Risk and Liability: Many financial advisors and attorneys hesitate to take on the trustee role due to the personal liability involved. If a mistake is made—such as failing to review a policy or mishandling trust distributions—they could be held responsible for financial losses.
Lack of Long-Term Continuity: If the trustee retires or leaves the profession before the trust funds, the grantor will need to find a new trustee—an issue that will likely arise given the 32-year average trustee term.
The Benefits of a Corporate Trustee
Given the risks associated with both individual and professional trustees, a corporate trustee can provide a more secure and reliable alternative. Here’s why:
Specialized Expertise: Corporate trustees have extensive experience managing ILITs and life insurance policies, actively monitoring policy performance to prevent unnecessary lapses and tax issues.
Impartial and Conflict-Free: Unlike individual trustees who may have personal relationships or financial interests at stake, a corporate trustee remains neutral, ensuring that all decisions are made in the best interest of the beneficiaries.
Regulatory Compliance: Corporate trustees ensure ILITs remain in compliance with tax laws, trust regulations, and fiduciary best practices—reducing the risk of costly mistakes.
Efficient Administration: A corporate trustee takes on the time-consuming administrative duties of ILIT management, ensuring all policies are reviewed regularly and that Crummey notices and other compliance measures are properly handled.
Long-Term Stability: Unlike an individual or professional trustee who may retire or pass away, a corporate trustee provides institutional stability, ensuring the ILIT remains properly managed for decades.
Learn More: Your Guide to Choosing a Corporate Trustee
Educating Your Clients on Trustee Selection
If your clients have chosen an individual or professional trustee for their ILIT, it’s essential to have a conversation about the risks involved. The increasing complexity of trust-owned life insurance management requires expertise, stability, and an ongoing commitment that many trustees simply cannot provide. Encouraging clients to explore corporate trustee options can help protect their wealth, ensure their wishes are carried out properly, and provide their beneficiaries with long-term security.
Download this flyer with the top 5 reasons not to use an individual trustee to help start the conversation with your clients.
