Irrevocable Life Insurance Trust (ILIT): 3 Brilliant Strategies


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If you are worried about estate taxes when you die, you may consider an irrevocable life insurance trust.

As the name suggests, it’s irrevocable, meaning you can’t change the trust once you open it. The trust can hold many assets, but more importantly, it holds your life insurance, keeping it separate from your estate, and lowering the risk of high estate taxes when you die. The trust owns and pays the life insurance premiums, and you name a beneficiary to receive the proceeds when you die.

How Does it Work?

You can set up an irrevocable life insurance trust as a part of your estate. The trust holds your life insurance, and you assign trust beneficiaries to receive the proceeds when you die. You can transfer other assets to the trust as well, just know that once you transfer them into the trust, it’s difficult to remove them.

Since the trust is irrevocable, you usually can’t change the beneficiaries either. Give careful thought to how you set it up before finalizing the paperwork to ensure you’ll be happy with the situation 20+ years down the road.

Steps to Open an Irrevocable Trust

Setting up an irrevocable trust requires a few simple steps:

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  • Open the trust – You’ll create the trust by funding it. The trust needs money to pay for the life insurance premiums since the trust owns the life insurance policy – not you. This is how you avoid estate taxes.
  • Choose an administrator – Next, you’ll choose a trustee or person to administrate the trust. This should not be you or you risk losing the benefit of avoiding estate taxes.
  • Buy your life insurance policy – The trustee should purchase the life insurance policy, with you as the insured. Notice, you aren’t buying the policy – the trustee buys it, but to insure your life.

If you already have life insurance, you can easily transfer it to the trust. You’ll transfer the ownership from yourself to the trustee, but you remain the insured person. Be careful, though. If you die within 3 years of transferring your existing life insurance to the trust, the IRS may still count it toward your estate and tax the estate. If you want to transfer your life insurance to a trust, do it early.

  • Choose beneficiaries – The trust is the beneficiary of the life insurance funds, but your trust should have beneficiaries (instructions on who should receive the proceeds). You create the rules, but remember, you can’t change them once they’re set.

Life Insurance and Estate Values

Life insurance proceeds that aren’t in a trust could increase your estate’s value. If your estate exceeds the 2021 limit of $11.7 million, the life insurance proceeds are taxable. If the estate is worth less than $11.7 million with the life insurance proceeds included, there aren’t any estate taxes.

If the life insurance is held in an irrevocable trust, it doesn’t become a part of the estate because you aren’t the owner – the trust owns the policy. The beneficiaries may owe taxes on any interest earned on the distribution, but not on the original amount.

The Irrevocable Life Insurance Trust and Taxes

Taxes can become an issue with your estate, depending on its value, as we spoke about above. But, when you set up the irrevocable trust correctly, life insurance doesn’t play a role because you don’t own it.

You must make sure you are not the trustee of the trust, this would give you incidence of ownership. When you open the trust, designate someone else the trustee and ensure that the trust has enough money to cover the life insurance premiums for your expected lifetime.

How is this different than if you have a standard policy with beneficiaries?

While beneficiaries typically don’t pay taxes on the proceeds from a life insurance payout (unless there are interest or dividend earnings), it does affect the estate’s value, which affects the estate’s tax liabilities.

If the life insurance increases the estate’s value enough, the estate would owe taxes, which would decrease the proceeds your beneficiaries receive.

Funding the Trust and Using Crummey Powers

When you’re funding the trust, you may want to take advantage of the gift tax exclusion, which in 2021 is $15,000.

With Crummey Powers, you can exclude the $15,000 using the gift tax exclusion if you give your beneficiaries proper notice that you’re funding the trust with the money and they have X number of days to withdraw it. This is their legal right, and it must be at least 30 days.

If the beneficiaries don’t exercise their right to withdraw the funds, the trust can use the funds to cover your life insurance premiums. All beneficiaries must be sent Crummey notices within the allotted time frame so work with your attorney to make sure you cover your bases.

Is an Irrevocable Life Insurance Trust Right for You?

An irrevocable life insurance trust isn’t necessary for everyone. It mostly benefits those with a large estate. If you think your estate will exceed the tax exclusion limits, it’s to your benefit and the benefit of your beneficiaries to put your life insurance into an irrevocable trust.

Make sure you’re aware of the requirements including that you cannot make changes once you set it up. Take your time deciding how to set it up including who you should designate as trustee and beneficiaries.

The nice thing about the irrevocable life insurance trust is the money is protected from creditors during your lifetime or even your beneficiaries’ lifetime as long as the funds remain in the trust. The trust owns the assets, not anyone else, so no one can touch it should they run into trouble with creditors.

Paul Sundin

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