Estate planning is a critical process for ensuring that your assets are distributed according to your wishes after your passing. One powerful tool that can be used in estate planning is the Irrevocable Life Insurance Trust (ILIT). This legal entity can help you manage your life insurance policies in a way that maximizes the benefits for your heirs while minimizing the tax burden. In this post, we’ll explore what ILITs are, how they work, and why they might be a valuable addition to your estate plan.
What is an Irrevocable Life Insurance Trust (ILIT)?
An Irrevocable Life Insurance Trust (ILIT) is a trust specifically designed to own and manage a life insurance policy. Once established, the trust is irrevocable, meaning it cannot be altered or revoked without the consent of the beneficiaries. The primary purpose of an ILIT is to remove the life insurance policy from your taxable estate, thereby reducing or eliminating estate taxes upon your death.
How Does an ILIT Work?
- Creation of the Trust: You (the grantor) work with an estate planning attorney to create the ILIT. The trust is named as the owner and beneficiary of the life insurance policy.
- Transfer of the Policy: If you already own a life insurance policy, you transfer ownership to the ILIT. If you don’t have a policy, the trust can purchase one on your behalf.
- Funding the Trust: To pay the premiums, you make cash gifts to the trust. These gifts are typically structured to qualify for the annual gift tax exclusion (currently $19,000 per beneficiary in 2025).
- Trust Administration: The trustee (a person or institution you appoint) manages the trust, pays the premiums, and ensures compliance with legal requirements.
- Distribution of Proceeds: Upon your death, the life insurance proceeds are paid to the trust. The trustee then distributes the funds to the beneficiaries according to the terms of the trust.
Benefits of Using an ILIT in Estate Planning
- Estate Tax Reduction: Since the life insurance policy is owned by the trust, the proceeds are not included in your taxable estate. This can significantly reduce or eliminate estate taxes.
- Asset Protection: The funds in the ILIT are protected from creditors and legal judgments, providing an added layer of security for your beneficiaries.
- Control Over Distributions: You can specify how and when the proceeds are distributed to your beneficiaries, ensuring that the funds are used according to your wishes.
- Avoiding Probate: Life insurance proceeds held in an ILIT bypass probate, allowing for faster and more private distribution to beneficiaries.
- Gift Tax Advantages: By using the annual gift tax exclusion, you can fund the ILIT without incurring gift taxes.
Key Considerations When Setting Up an ILIT
- Irrevocability: Once the ILIT is established, you cannot change its terms or reclaim ownership of the life insurance policy. Careful planning is essential.
- Trustee Selection: Choose a trustee who is reliable and knowledgeable about trust administration. This could be a family member, friend, or professional trustee.
- Crummey Letters: To qualify for the annual gift tax exclusion, beneficiaries must be given notice of their right to withdraw the gifted funds (known as Crummey letters). This is a legal requirement for ILITs.
- Legal and Administrative Costs: Setting up and maintaining an ILIT involves legal fees and administrative expenses. Ensure that the benefits outweigh the costs.
- Policy Ownership: If you transfer an existing policy to the ILIT, you must survive for at least three years after the transfer for the proceeds to be excluded from your estate.
Is an ILIT Right for You?
An ILIT is not suitable for everyone, but it can be an excellent tool for individuals with large estates who want to minimize estate taxes and provide for their loved ones. If you’re considering an ILIT, consult with an experienced estate planning attorney to determine if it aligns with your financial goals and estate planning needs.
