However, if you use an irrevocable life insurance trust, or ILIT, to hold title to your life insurance policy, you may avoid having the death benefit included as an asset in your estate. This can save your heirs hundreds of thousands (maybe even millions!) of dollars in taxes.
It’s not something to try on your own, but creating an ILIT might be worth it.
Motley Fool’s recent article, “What's an Irrevocable Life Insurance Trust and Why Do I Need One?” explains just what an irrevocable life insurance trust looks like.
An ILIT is a trust with the primary purpose of holding a life insurance policy and the cash needed to pay premiums on that policy. You would need to fund the trust with money to pay initial premiums when you set it up. The trust then buys the life insurance policy, naming you as the insured.
The ILIT has to be created so that it avoids giving you “incidents of ownership.” These are the rights to borrow against the policy, to change beneficiaries or to change how proceeds are distributed from the trust. If you retain any of these rights, then the death benefit will be included in your estate and subject to estate taxes.
The ILIT usually pays the ongoing premiums by receiving future gifts from you as the person who set up the trust. After your death, the other provisions of the trust will apply.
The major benefit of the ILIT is that the proceeds of the life insurance policy aren’t taxed. The estate tax on a $1 million policy can be as much as $400,000—so the savings from an irrevocable life insurance trust makes having an attorney create it for you a smart option. However, if an existing life insurance policy is gifted into the ILIT, the grantor must survive three years from the date of the transfer if the insurance proceeds are to count as outside the gross estate and not be subject to estate taxes.
There can be some issues with ILITs—the most common of which is when the cost of continuing the life insurance policy becomes prohibitively high. That can make the ongoing funding of the trust burdensome. The ILIT trustee might have to borrow against the policy value or surrender the policy entirely. It can mean that the beneficiaries are at odds with the trustee. That’s why it’s important to work with an insurance professional to ensure you pick the right type of coverage for your family and understand the costs associated with that type of insurance.
While we at Family Estate Planning Law Group do not sell insurance, we know that to reap the most benefits, it is critical that your estate plan, insurance policies, trusts and tax planning are all aligned. If your ILIT is properly managed, you may save your heirs from facing a large tax burden. Speak with an estate planning attorney to ensure that each part of your plan works with the other and that your ultimate goals will be met.
For more information, explore our website and contact us to schedule your consultation today!
Reference: Motley Fool (August 24, 2016) “What's an Irrevocable Life Insurance Trust and Why Do I Need One?”