WHAT IS IT?
An Irrevocable Life Insurance Trust (ILIT) is an irrevocable trust that provides a means of avoiding estate taxes on life insurance proceeds, while providing a benefit for your spouse and/or children.
WHO NEEDS IT?
Any individual whose estate may or will have an estate tax liability should consider an ILIT to avoid having life insurance proceeds included in the estate and causing or increasing estate tax liability.
WHAT DOES IT DO?
An ILIT avoids estate taxes on life insurance proceeds by taking life insurance out of the taxable estate. Life insurance is considered part of the taxable estate when the following occurs: (1) Upon your death, the life insurance proceeds are paid directly or indirectly to your estate; or (2) When you were alive, you held any ownership interest in the life insurance proceeds. Ownership interest includes the right to change a beneficiary, surrender or cancel the policy, or borrow against the policy. If you leave the proceeds to anyone other than a spouse, such as a child, parent, or friends, then your estate will be taxed. If you leave the proceeds to a spouse, then your estate will not be taxed, but your spouse's will be.
An ILIT takes the life insurance out of the taxable estate by placing the life insurance into an irrevocable trust, then naming another individual (not yourself) as the trustee. A life insurance policy placed into an ILIT is considered to have no owner, therefore it is not considered part of your estate. The ILIT is also considered the beneficiary of the life insurance proceeds, which keeps the proceeds out of your, your spouse's and your children's estates. After the insured dies, the Trustee will invest the proceeds of the trust and administer the trust for its beneficiaries.
WHAT ARE THE BENEFITS?
Utilizing an ILIT can: (1) help avoid estate tax liability; (2) increase the size of your estate without increasing your estate tax liability; (3) provide liquidity to pay off liabilities or tax obligations without selling other assets; (4) allow for transfers out of the estate with minimal or no gift tax consequences; (5) protect beneficiaries from creditors; and (6) provide an ongoing management of assets under the terms of the trust.
HOW DO I SET IT UP?
There are two ways to set up an ILIT: (1) You can purchase a life insurance policy in the name of the trust; or (2) You can transfer an existing life insurance policy into the trust.
It is preferrable to purchase a life insurance policy in the name of the trust rather than transferring an existing life insurance policy into the trust. Transferring an existing policy into a trust triggers a three-year survival rule, whereby the original policy owner must survive the date of transfer by three years or the life insurance proceeds will be included in the decedent's estate for estate tax purposes as if the transfer never occurred.
If the insured has a spouse, the ILIT should contain a fail-safe clause, providing that if the insured/transferor dies within three years of the transfer of any policy to the ILIT, then the proceeds of such a policy will be held separately under the ILIT and administered for the surviving spouse in a way that