Mitigating Estate Taxes by Using an Irrevocable Life Insurance Trust – The Basics

Many of us have taken precautions to provide for our loved ones and purchased a life insurance policy to support our families when the time comes. Unfortunately, in some instances, your family members and loved ones may not be receiving nearly as much as you thought they would due to estate taxes. Often times, an irrevocable life insurance trust, or ILIT, can be a critical tool for your family’s financial planning and financial well-being.

What is an ILIT? 

An ILIT is a trust that you, the grantor, create to hold your life insurance policy for you. By purchasing the policy in the name of your ILIT, you remove the policy from your estate, and consequently, your estate will not be subject to an estate tax on the policy once it is disbursed. This huge benefit comes with some strings attached; an ILIT is, by definition, irrevocable, so once you create the trust, you may not place the policy back in your own name.

Like any other trust, an ILIT has a trustee and beneficiaries. The trustee manages the trust, and the beneficiaries benefit from the funds that are eventually disbursed from the trust. Once the funds from your policy are disbursed to the ILIT, the ILIT trustee will disburse the funds to the beneficiaries of the ILIT. The ILIT trustee will pay the beneficiaries in whatever way the settlor intended, which can include paying all of the proceeds out immediately, having recurring payments, or even having payments made subject to certain conditions (such as age, graduation, or marriage).

Why Should I Create an ILIT?

Creating an ILIT has several benefits. First, avoiding estate taxes and gift tax consequences, or minimizing your estate tax liability can save you and your family a lot of money. While many individuals don’t believe they will be subject to estate taxes, some often fail to realize that a life insurance policy is a part of your estate, unless it is held in an ILIT. Some of you may not feel like millionaires, but may still be subject to an estate tax at death due to your life insurance death benefit. By creating an ILIT you can avoid having to add the proceeds of your life insurance policy to your estate, which can substantially reduce or even eliminate your estate tax liability.

An ILIT can also help to protect your life insurance proceeds from the creditors of a beneficiary (the individual(s) receiving the proceeds following the settlor’s death) because the trustee has discretion in making distributions. This protection can be vital for beneficiaries who are minors, or for any beneficiary that may be in need of other financial protections.

What about Insurance Premiums?

Once you create your ILIT, you, as the grantor, must take great care to pay the premiums in a way that does not violate the irrevocable nature of the ILIT. A grantor must not have any “incidents of ownership” over the policy, and if there is, then the ILIT will be seen as invalid and the life insurance policy will be included in the settlor’s estate, and will be included in your estate tax liability.

Conclusion

Creating an ILIT helps protect your family and their financial well-being. You may have paid a lot of taxes in your life; work with us to avoid paying a lot of them after your death too. Creating an ILIT correctly is crucial to the success of the ILIT, and so it is important that you consult with an attorney. Lavelle Law has extensive experience in complex estate planning. Feel free to call (847) 705-7555 or email Mélyse Mpiranya at mmpiranya@lavellelaw.com to get started.