What is an Irrevocable Life Insurance Trust (ILIT)?
An Irrevocable Life Insurance Trust is a powerful estate planning structure that is used in tandem with a life insurance policy on the life of the grantor to provide funds for the grantor’s beneficiaries after the grantor’s death.
A life insurance policy is typically purchased by the trust using funds provided by the grantor. These funds are usually in the form of a non-taxable transfer either utilizing an individual’s lifetime federal estate and gift tax exemption ($12.92 million in 2023) and/or utilizing each person’s annual federal gift tax exemption ($17,000 in 2023). Funds can also be loaned to an Irrevocable Life Insurance Trust or transferred as a taxable gift.
When the grantor dies, the death benefit from the life insurance policy is paid out to the trust. Those proceeds are not part of the grantor’s estate, not subject to income or estate taxation and can be used to pay estate taxes and to provide for trust beneficiaries.
Edward is a 55-year-old business owner who wants to ensure that his family is financially secure in the event of his untimely death. He has a net worth of $15 million. Edward is concerned that his estate will be subject to estate taxes upon his death, and he wants to minimize the impact of those taxes on his family.
After consulting with his financial advisor, Edward decides to set up an Irrevocable Life Insurance Trust, which is managed by a trustee he selects. Edward’s wife and children are named as the beneficiaries of the trust.
Edward decides to make annual gifts to the trust to pay the premiums on a life insurance policy purchased by the trust. He uses a combination of his annual federal gift tax exclusion and his federal lifetime estate and gift tax exemption to make the gifts. Edward understands that the trust is irrevocable and once he transfers funds, he can no longer change his mind and take back the money.
As the grantor to the Irrevocable Life Insurance Trust, Edward is responsible for taxes owed for any income produced by assets within the trust. This arrangement prevents the trust corpus from being eroded by taxation while Edward and Susan are alive and, by paying these taxes from funds held outside of the ILIT, Edward further reduces the value of his estate.
The trust is designed so that when Edward passes away, the death benefit from the life insurance policy will be paid out to the trust. The trustee will then distribute the proceeds to Edward’s wife and children according to the terms of the trust.
By setting up the ILIT, Edward is able to keep the life insurance policy from his taxable estate, which will reduce the amount of estate tax his family will have to pay. The ILIT also provides additional benefits, including protection of the life insurance proceeds from creditors and potential lawsuits.
The Advantages of an Irrevocable Life Insurance Trust
- Minimizes Estate Taxes – The trust owns the policy, so it is not subject to federal income taxes.
- Eliminates Gift Taxes – The transfer of funds can be treated as a present gift that may not be taxed, as opposed to a future gift that is.
- Protects Assets – It can limit the amount of funds that creditors may pursue.
- Controls Distributions – The trust controls when and how the life insurance proceeds are paid to trust beneficiaries.
- Plans for Generational Wealth Transfer – The trust can provide for future generations, even those who have not yet been born.
- Shields from Tax Penalties – The policy’s cash value and death benefit may not be taxed.
A Choice of Irrevocable Trusts
There are many types of irrevocable trusts which meet a range of planning needs. The most popular forms of ILITs utilized in estate planning include:
Spousal Lifetime Access Trust (SLAT) – An ILIT established by one spouse for the benefit of the other spouse, providing the beneficiary spouse with access to trust assets while potentially removing them from the taxable estate of the other spouse.
Grantor Trust – A person (grantor) transfers assets to an ILIT, while still retaining certain control or benefits, allowing the grantor to avoid immediate taxation on income generated by the trust.
Dynasty Trust – An ILIT that allows a long-lasting lineage or family to exercise and maintain power and influence over trust assets for multiple generations.
Second-to-Die Trust – Assets are held in an IIT until the death of both spouses, at which point they are transferred to the designated beneficiaries.
Choosing Life Insurance
A permanent cash value policy is often the most suitable form of a policy to be owned by an ILIT. Types of permanent cash value policies include whole life, universal life, variable universal life and private placement life insurance. The policy can insure one or two people and can be designed to include performance guarantees and to provide liquidity for unexpected events, including to pay for long-term care and critical illness costs.
Have more questions about an Irrevocable Life Insurance Trust? Our Optifino Concierges are here to help answer any questions you and your family may have about life insruance.
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