What Is an Irrevocable Life Insurance Trust?
An irrevocable life insurance trust (also called an “ILIT”) has at least one life insurance policy as a trust asset. The life insurance policy usually is taken out on the life of the trust creator, but the trust itself owns the policy. The trust is also the policy’s beneficiary.
As a result, when the trust creator dies, the life insurance company pays the policy proceeds directly into the trust. The trustee should invest and manage those assets for the benefit of trust beneficiaries. These beneficiaries receive the ultimate gift of payments from the trust, which now holds the life insurance money and any interest or gains that it earns.
This kind of trust must be irrevocable, meaning that the trust creator cannot change the trust at all (or access the life insurance policy) once the trust begins operating.
Are There Tax Benefits to Starting an ILIT?
Yes, irrevocable life insurance trusts offer tax benefits to the trust creators. As long as you have no “incidents of ownership” in the trust, then the IRS will not consider the ILIT as part of your taxable estate for purposes of assessing estate tax. Incidents of ownership include the ability to change the trust terms, change the beneficiaries, or remove property from the trust.
For ILITs specifically, owning the life insurance policy that is in trust is an incident of ownership. That is why the trust must own the policy. Otherwise, the IRS might say that the ILIT is part of the taxable estate, greatly increasing possible estate taxes depending on the value of the policy.
Unfortunately, the IRS will consider an ILIT to be part of a trust creator’s taxable estate if he or she dies within three years of transferring the life insurance policy to the trust. Many people avoid this problem by having the trust purchase the policy instead. Then they contribute money to the trust all at once or over time, and the trust can use this money to pay the policy premiums. If you take this route, be aware that the trust beneficiaries will have the right to request their shares of the money you contribute to the trust for premium payments, for a short time after you make each contribution.
For more help determining if an irrevocable life insurance trust is right for you, talk to an estate planning attorney familiar with forming ILITs. Be sure to update the rest of your estate plan regularly too.
Planning your estate? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.