What is an irrevocable life insurance trust (ILIT)?
An irrevocable life insurance trust (ILIT) is an effective estate planning tool designed to collect the proceeds of your life insurance from a term insurance, permanent insurance, or second-to-die policy for the benefit of your family or other heirs without incurring federal or state income taxes or transfer (i.e., estate or generation-skipping transfer tax) taxes.
How does an ILIT work?
If properly structured, the insurance proceeds can be made available to replace funds used by your estate and trusts to pay any estate taxes arising upon your death. Other advantages of creating an irrevocable life insurance trust are that:
- the proceeds can escape the claims of creditors; and
- the proceeds may not be subject to a spouse’s claim against your estate.
What are the disadvantages of an ILIT?
The primary disadvantage of having a life insurance policy held by an inter vivos (i.e., living) irrevocable trust (i.e., an irrevocable trust created during your lives) is that you are not allowed to retain the power to change beneficiaries of the trust or their rights to participate in insurance proceeds once the trust is executed. While there are ways of modifying irrevocable trusts, retaining the right to change the beneficiaries may cause the entire proceeds of life insurance to be included in your estate at your death.
You must be willing to relinquish control of the assets transferred to the trust to a separate trustee. If you are married, your spouse can serve as the trustee and still have the right to receive income and principal for his or her health, education, maintenance, and support, without causing the proceeds to be included in his or her estate.
Again, you cannot retain any economic benefit in the life insurance policy owned by the trust and must be able to transfer all the benefits to the trust. For example, you will not be able to retain the right to cash in or borrow directly against the cash surrender value of any life insurance policy after it is transferred to or acquired by the trust.
Why use an ILIT at all?
With the estate and gift tax exemptions scheduled to drop by half at the end of 2025, ILITs will serve as an important estate planning tool for you and your loved ones.