Thinking of Creating an Irrevocable Life Insurance Trust?
Before addressing the question as to whether an Irrevocable Life Insurance Trust (ILIT) might be right for your estate planning needs, it is important to understand exactly what an ILIT is.
A trust is a transfer of property involving three people:
- The grantor, who provides the property;
- The trustee, who receives and manages the property for the benefit of one or more third parties; and
- One or more beneficiaries
What the beneficiaries receive and when is dependent on the terms of the trust.
Generally, a trust may be revocable or irrevocable. A revocable trust may be withdrawn or altered by the grantor, whereas property transferred to an irrevocable trust has been transferred permanently, just as if the grantor had given or sold it to another person. ILITs must be irrevocable in order to serve one of their most important purposes: estate tax management.
Finally, as the name suggests, an ILIT is created to own a life insurance policy.
Why Use an Irrevocable Life Insurance Trust?
It may not be immediately clear why anyone would need to create an ILIT. It is, after all, simple enough to purchase a life insurance policy and name a beneficiary, who will then receive payment directly. However, there are possible benefits to creating an ILIT and transferring the life insurance policy to the trust, or providing funds for the trust to purchase the life insurance policy.
Estate Tax Advantage of an ILIT
When the grantor owns the life insurance policy, the policy is considered a part of the estate for tax purposes. For many people, that makes no financial difference. However, a large life insurance policy may push the value of an estate over the limit and result in payment of significant estate taxes. When an ILIT owns the life insurance policy, it is not property of the deceased and does not become a part of the estate. Thus, the life insurance policy has no impact on the value of the estate for tax purposes.
Controlling the Proceeds of Life Insurance
When an individual purchases a life insurance policy directly, lists a beneficiary and then passes away, the beneficiary will receive the proceeds outright. Often, that is the desired outcome, but it is not appropriate in all cases. When the grantor wants to prevent the full proceeds of the policy from being directly paid out all at once, a trust provides that degree of control. The terms of the trust may authorize the trustee to pay out only the interest, make payment of certain types of expenses, dispense the funds in installments, or otherwise control or limit the distribution to one or more beneficiaries.
ILIT Drawbacks and Concerns
While ILITs offer certain advantages, they are not the right answer for everyone. One serious concern about ILITs is the fact that they are irrevocable. Thus, taking this approach requires careful consideration. The grantor will not be able to terminate the trust and regain control of the life insurance policy.
In addition, a person planning to make use of an ILIT, particularly for tax purposes, must do so according to very specific rules that might never occur to the average person. For example, naming the personal representative of the grantor’s estate as a beneficiary may eliminate the tax benefits and trigger the inclusion of the life insurance proceeds in the estate. Thus, creating an effective ILIT requires careful planning and either extensive research or the guidance of a professional knowledgeable about ILITs.
Determining Whether an Irrevocable Life Insurance Trust is Right for You
ILITs can be important tax planning tools and may serve as a means of controlling the distribution of funds left for your loved ones. However, they are neither necessary nor advisable for everyone. Talking with an experienced estate planning lawyer is the best first step toward deciding whether an ILIT is right for you.
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