Irrevocable Life Insurance Trusts

The irrevocable life insurance trust (often just called by its abbreviation ILIT) is a common estate tax planning tool.  Many people have life insurance policies that contribute significantly to the estate taxes that would be owed by their estates.  Removing life insurance from an estate can go a long way toward fixing estate tax problems.

Rather than owning your life insurance directly, the ILIT can be the owner of the policy.  Gifts are made to the ILIT each year to pay the life insurance premiums.  If you can make annual exclusion gifts (the $13,000 Gift Rule) to the ILIT, the gifts won’t be taxable as long as the life insurance premium is low enough.

When the insured (or insureds, on a second to die policy) dies, the life insurance proceeds are paid into the ILIT.  From there, the proceeds can either be paid directly to the beneficiaries or continue to be held in trust for their benefit.  By using an irrevocable life insurance trust in this way, you can transform a future gift of life insurance proceeds into present gifts of premiums.

But why not just gift the policy directly to your children or buy it in their name to begin with?  There are several advantages to using an ILIT beyond just the potential estate tax savings.

Retain Control

As the creator of the irrevocable life insurance trust, you will decide who the trustee is and how your beneficiaries will receive the proceeds.  And although you cannot borrow against the cash value of the policy, your trustee can be given that right.  The borrowed money can be distributed to or spent on any of your lifetime beneficiaries (usually your spouse and children).

Create Liquidity

Sometimes an estate owes taxes, but there just isn’t enough cold, hard cash in the estate to pay them.  The result can be a fire sale—with assets being sold for far less than fair value.  This problem is most common among business owners (particularly those who pumped all the profits back into the business) and people with multiple properties.

Life insurance can be a great liquidity boost for your estate—supplying the cash to pay expenses and taxes.  But if the policy is owned by your children, the liquidity benefit is lost.  An ILIT retains the liquidity benefits of the life insurance because the ILIT can buy assets from the estate—avoiding a fire sale.

Keep Flexibility

Gifting a policy or premium payments to your children may help solve some of your estate tax problem, but what if your spouse needs access to the proceeds?  With an ILIT, the proceeds can be made available to your spouse during their lifetime—without being included in their estate when they die.

Protect Your Beneficiaries

Life insurance proceeds paid directly to a beneficiary are exposed to being lost in a variety of ways—creditors, divorce, poor decisions.  An ILIT can be designed to protect the life insurance proceeds so it’s there when your beneficiaries need it.