Irrevocable Life Insurance Trust: Purpose And Benefits Explained

An irrevocable life insurance trust (ILIT) is a legal arrangement that allows people to set aside assets for certain purposes, such as paying estate taxes. The main purpose of a life insurance trust is to decrease the value of an individual's estate in order to reduce the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary. When the grantor dies, the life insurance trust will continue to collect the benefits and then distribute them to the trust beneficiaries as determined by the grantor when the trust was created.

How an irrevocable life insurance trust works

An irrevocable life insurance trust (ILIT) is a legal arrangement that seeks to minimise your current tax burden as well as the impact taxes will have on your estate. It does this by transferring assets from you to the trust, and using a life insurance policy to distribute the proceeds when you pass away.

ILITs are created during the insured's lifetime and own and control a term or permanent life insurance policy or policies. The trust can also manage and distribute the proceeds that are paid out upon the insured’s death, according to the insured's wishes.

The main purpose of a life insurance trust is to decrease the value of an individual's estate in order to reduce the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary. In order to do this, the selected assets must be moved into the trust at least three years before they are used.

When an ILIT purchases a life insurance contract, the contract's death benefit will typically not be included in the insured's federal taxable estate. This differs from a scenario where life insurance death benefits are paid to an individual, because the proceeds are included in the taxable estate of the decedent.

The benefits of an irrevocable life insurance trust

An irrevocable life insurance trust (ILIT) is a legal arrangement that seeks to minimise your current tax burden as well as the impact taxes will have on your estate. It does this by transferring assets from you to the trust, and using a life insurance policy to distribute the proceeds when you pass away.

The benefits of an ILIT are:

• It can be used to set aside assets for certain purposes, such as paying estate taxes, because these assets themselves are not taxable.
• The death benefits paid to the ILIT will be free from inclusion in the gross estate of the insured.
• It can decrease the value of an individual's estate, reducing the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary.
• It protects the benefits stemming from a life insurance policy from estate taxes.
• It can be used to support your loved ones financially.

The difference between a revocable and irrevocable life insurance trust

An irrevocable life insurance trust (ILIT) is a legal arrangement that seeks to minimise an individual's current tax burden and the impact of taxes on their estate after their death. This is achieved by transferring assets from the individual to the trust, which will then distribute the proceeds of a life insurance policy to beneficiaries according to the wishes of the deceased.

The main difference between a revocable and an irrevocable life insurance trust is that a revocable trust can be altered or undone after it is created, whereas an irrevocable trust cannot. This means that an irrevocable trust is a mostly unchangeable arrangement, whereas a revocable trust is changeable.

Another difference is that the proceeds of a revocable life insurance trust are included in the taxable estate of the decedent, whereas the proceeds of an irrevocable life insurance trust are not. This is because the assets of an irrevocable trust are not taxable. This means that an irrevocable trust can be used to reduce the value of an individual's estate, and therefore the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary.

A further difference is that, in order for the death benefits paid to an irrevocable trust to be free from inclusion in the gross estate of the insured, the selected assets must be moved into the trust at least three years before they are used. This requirement can be circumvented by creating new policies in a spouse's name.

Who can benefit from an irrevocable life insurance trust

An irrevocable life insurance trust (ILIT) is a legal arrangement that seeks to minimise an individual's current tax burden and the impact of taxes on their estate. It does this by transferring assets from the individual to the trust, which are then distributed to beneficiaries upon the individual's death.

ILITs are beneficial to those who want to support their loved ones financially after their death, as the death benefits paid to the trust are not taxable. This is in contrast to a scenario where life insurance death benefits are paid to an individual, as the proceeds are included in the taxable estate of the decedent.

ILITs are also useful for those who want to reduce the value of their estate, as the trust can manage and distribute the proceeds of a life insurance policy according to the individual's wishes. This is particularly beneficial for those with a high net worth, as it can reduce the amount of estate tax that needs to be paid.

Currently, only the wealthiest Americans benefit from setting up an ILIT due to the high estate tax exemption limits. However, these limits are due to be cut in 2025, meaning more people may benefit from ILITs in the future.

How to set up an irrevocable life insurance trust

An irrevocable life insurance trust (ILIT) is a legal arrangement that seeks to minimise your current tax burden as well as the impact taxes will have on your estate. It does this by transferring assets from you to the trust, which uses a life insurance policy to distribute the proceeds when you pass away.

To set up an ILIT, you must first draw up and sign the trust documents. You can then fund the trust with an existing life insurance contract or a new one. If you are using an existing contract, you will need to change the contract's owner to the trust. You may also need to change the contract's beneficiary to the trust, depending on how you want the death benefit to be distributed.

The trustee, who can be a friend, relative or independent professional, will use the assets to purchase a life insurance policy in your name and will continue to pay the premiums so the policy remains in force. When you die, the policy's death benefit is paid directly to the trust, which will then distribute the proceeds to any beneficiaries you have named.

It is important to note that setting up an ILIT can be a complex endeavour, so it is recommended that you seek the specific expertise of a qualified estate planning attorney who specialises in trusts.

Frequently asked questions