Irrevocable Life Insurance Trusts: Protecting Your Wealth And Legacy

An irrevocable life insurance trust (ILIT) is a legal arrangement that helps minimize an individual's current tax burden and the impact of taxes on their estate. It is set up during the insured's lifetime and owns and controls their life insurance policy or policies. The primary benefit of an ILIT is that it helps protect the benefits stemming from a life insurance policy from estate taxes, which can claim over 40% of the policy value. Additionally, it can help set aside assets for family members with special needs without interfering with their eligibility for government benefits. However, the main downside of an ILIT is that it cannot be altered or revoked once created, which may have severe implications if the grantor unexpectedly needs those assets in the future.

Avoid estate taxes

An irrevocable life insurance trust (ILIT) is a powerful tool for wealth management and can be used to minimise estate taxes. Life insurance proceeds are typically subject to estate taxes, which can greatly reduce the amount that beneficiaries receive. By placing an insurance policy in an ILIT, the death benefit is removed from the estate, reducing the tax basis and potentially negating the tax burden.

ILITs are particularly useful for individuals with assets at or above federal and state estate tax exemption thresholds. Many states begin taxing estates at $1 million or less, and while the federal exemption was $12.92 million in 2023, this could change in the future. By using an ILIT, the value of the life insurance death benefit is excluded from the grantor's gross taxable estate, ensuring beneficiaries receive the full amount.

The proceeds from an ILIT can also be distributed to multiple generations of a family, including children, grandchildren and great-grandchildren, without incurring additional estate taxes. This is achieved by using gifts to the trust to buy and fund a life insurance policy, which is then excluded from the grantor's estate. The trust can also be structured to give the trustee discretion over distributions, preventing a large lump sum from being given to a beneficiary with dependency or other issues.

It is important to note that an ILIT is irrevocable and cannot be altered or undone once created. As such, it may not be suitable for everyone, and individuals should consider their goals and specific circumstances before establishing one. Consulting with estate planning attorneys and financial advisors can help determine if an ILIT is the right choice for an individual's wealth management plan.

Protect government benefits

An irrevocable life insurance trust (ILIT) is a legal arrangement that helps protect government benefits. It does so by transferring assets from the grantor to a separate legal entity, the trust. The trustee, who can be a friend, relative, or independent professional, uses these assets to purchase a life insurance policy in the grantor's name. The trustee continues to pay the premiums so that the policy remains in force. When the grantor passes away, the policy's death benefit is paid directly to the trust, which then distributes the proceeds to the named beneficiaries.

ILITs are particularly useful for individuals with rapidly appreciating property or a growing business, as they can take advantage of higher estate tax exemption limits before they are halved. While the federal estate tax exemption is currently high, some states levy their own separate estate taxes. ILITs can help protect against these taxes and ensure that beneficiaries receive the full amount of insurance benefits.

One of the main benefits of an ILIT is its ability to protect government benefits. Since the proceeds of a life insurance policy are considered a financial asset, transferring ownership to an ILIT can make it easier for beneficiaries to qualify for Medicaid and other government assistance programs. This is especially relevant for families with a member with special needs, as an ILIT can help set aside assets for their care without interfering with their eligibility for government benefits.

It is important to note that ILITs are complex legal instruments, and it is recommended to consult a tax attorney, trust officer, or financial professional to determine if an ILIT is the right choice for your specific situation. While ILITs offer the advantage of protecting government benefits, they also have the downside of being irrevocable. Once an ILIT is created, it generally cannot be changed or revoked, and the assets transferred to the trust are no longer the grantor's. Therefore, careful consideration and planning are necessary before establishing an ILIT.

Provide for family members with special needs

An irrevocable life insurance trust (ILIT) is a trust created during the insured's lifetime that owns and controls a term or permanent life insurance policy. The trust can manage and distribute the proceeds that are paid out upon the insured's death, according to the insured's wishes. ILITs are a powerful tool that can be used in wealth management plans to benefit your family.

An ILIT can be particularly useful for providing for family members with special needs. Special needs can refer to any child with healthcare needs, physical, developmental, or mental conditions that impair their ability to function normally. These children often require additional assistance to perform daily tasks. By placing your life insurance policy in an ILIT, you can ensure that your family member with special needs will be taken care of in the way you want after you pass away, especially if they cannot manage assets on their own. The trustee will have complete discretion on how the assets are used and will handle and manage all distributions from the trust.

When the insured passes away, the death benefit from the life insurance policy will be in the trust without any income, gift, or estate taxes. This money will then be used to care for the family member with special needs until their death. This can be especially beneficial if you have substantial wealth, as it may help shield your beneficiaries from having to pay estate taxes on life insurance proceeds, preserving family wealth across generations.

It is important to note that the policy must name the trustee of the special needs trust as the beneficiary of the policy, rather than naming the trust itself or the individual with special needs. This is because the death benefit may be considered part of the deceased's estate if the insured owns the contract. By placing the contract in an irrevocable trust, the death benefit may be excluded from the estate, and the trust can be made the owner and beneficiary of the contract.

Protect assets from creditors

An irrevocable life insurance trust (ILIT) is a legal arrangement that helps protect your assets from creditors. It does this by transferring assets from you to a separate legal entity (the trust). The trustee, who can be a friend, relative, or independent professional, uses these assets to purchase a life insurance policy in your name. When you pass away, the policy's death benefit is paid directly to the trust, which will distribute the proceeds to your chosen beneficiaries.

ILITs are particularly beneficial for protecting assets from creditors and ensuring eligibility for means-tested government aid programs. The assets within an ILIT are generally safe from creditors' claims and are protected against civil lawsuits or bankruptcy. This includes the cash value and death benefits of the life insurance policy. By placing assets in an ILIT, you can also make it easier for your beneficiaries to qualify for Medicaid and other government assistance programs.

It is important to note that ILITs are irrevocable, meaning that once established, the trust generally cannot be changed or revoked. The assets placed in the trust are no longer the grantor's, and the terms of the trust agreement are set in stone. This could have implications down the road if you unexpectedly need access to those assets. However, in some cases, an irrevocable trust can be dissolved by the courts.

ILITs are a powerful tool for estate planning and can provide significant benefits for individuals, families, and business owners. They can help minimize estate and gift taxes, provide creditor protection, and protect government benefits. By removing taxable assets from your current portfolio, an ILIT may also help lower your current tax burden.

Avoid gift taxes

An irrevocable life insurance trust (ILIT) is an effective tool to avoid gift taxes. It is a type of irrevocable trust used to hold a life insurance policy, providing liquidity to the insured's estate free of federal estate taxes.

The main goal of an ILIT is to reduce the value of an individual's estate, thereby minimising estate tax exposure. This is achieved by transferring ownership of the life insurance policy to the trust, so that the value of the policy is not included in the calculation of the estate tax on the individual's estate. This can result in significant tax savings, especially for individuals with large estates.

In addition to reducing estate taxes, an ILIT can also be used to leverage the grantor's generation-skipping transfer (GST) tax exemption. By using gifts to the trust to fund a life insurance policy, the proceeds from the death benefit are excluded from the grantor's estate, allowing multiple generations of the family to benefit from the trust's assets free of estate and GST tax. This is particularly useful in blended family situations, where there may be children from multiple marriages.

To avoid gifts counting against the insured's lifetime gift tax exemption, it is important to utilise the annual gift tax exclusion. This allows individuals to gift a certain amount of money each year without incurring gift taxes. By making gifts of cash to the ILIT to cover the policy premiums, individuals can effectively reduce the size of their estate and minimise gift taxes.

Furthermore, an ILIT can provide protection for individuals who may require Medicaid or other government benefits in the future. By transferring ownership of the life insurance policy to the trust, individuals can ensure that the value of the policy is not counted against them when determining eligibility for such benefits. Overall, an ILIT is a powerful tool for individuals seeking to minimise their tax liability and protect their assets for future generations.

Frequently asked questions