An irrevocable life insurance trust (ILIT) is a trust created to hold life insurance policies, designed to protect the policy’s death benefit from estate taxes. An ILIT is a common tool used by estate planners to help clients avoid estate taxes and pass on wealth to their heirs.
Federal Estate Tax Parameters
When a person dies, their estate may be subject to federal estate taxes if the total value of their assets exceeds a certain threshold, currently set at $12.92 million. Life insurance death benefits can be included in the calculation of estate taxes, which can be a significant burden on the heirs who receive the policy proceeds.
How an ILIT Works
By creating an ILIT, the policy owner transfers ownership of the policy to the trust, effectively removing it from their estate for tax purposes. The trust becomes the policy owner and beneficiary, and the policy’s death benefit is paid directly to the trust upon the insured’s death. The trust then distributes the proceeds to the trust beneficiaries according to the terms of the trust.
Liquidity
An ILIT can also be used to provide liquidity to an estate. If significant assets are tied up in illiquid commodities such as real estate or a business, the estate may not have enough liquid assets to pay the estate taxes owed. An ILIT can provide the necessary cash to pay estate taxes without having to sell off assets or take out loans.
Asset Protection
In addition to providing tax benefits, an ILIT can also offer creditor protection. Since the trust owns the policy, the policy’s death benefit is not subject to the claims of the policy owner’s creditors. If the policy owner is sued or declares bankruptcy, the ILIT can provide a layer of protection for the policy proceeds.
Creating an ILIT
Creating an ILIT involves several steps. The first step is to establish the trust and transfer ownership of the life insurance policy to the trust. Secondly, the trust should have a named trustee, who is responsible for managing the trust assets and distributing the trust income and principal to the beneficiaries. It should also have a named beneficiary, who will receive the policy proceeds upon the insured’s death.
The trust must also be irrevocable, which means that the policy owner cannot change the terms of the trust or access the trust assets once the trust is created. This is an important aspect of an ILIT, as it ensures that the policy proceeds are not included in the policy owner’s estate for tax purposes.
Once the trust is established, the policy owner must make annual gifts to the trust to pay the policy premiums. These gifts can be given in a tax-free manner through the utilization of the annual gift tax exclusion, which is currently set at $17,000 per gift recipient per year. The policy owner may also make larger gifts to the trust to help fund the policy, but these gifts may be subject to gift taxes.
An ILIT can be a powerful estate planning tool for individuals who want to pass on wealth to their heirs while minimizing estate taxes. However, it is important to work with an experienced estate planning attorney to ensure that the ILIT is set up correctly and that the policy owner understands the implications of transferring ownership of the policy to the trust.
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Whether your estate will be exposed to estate taxes or not, we can help you create a custom-crafted plan that ideally suits your needs. You can set up a consultation appointment at our Glastonbury or Westport, CT estate planning offices if you call us at 860-548-1000, and you can use our contact form to send a message.
Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.