Irrevocable Life Insurance Trusts (“ILITs”) are trusts that are designed to distribute life insurance proceeds to a person’s heirs upon the insured person’s death. ILITs are difficult to modify, and they prohibit the insured from having any control over the insurance policy. The insured cannot be a beneficiary of their ILIT nor can the insured be a trustee. By making a life insurance trust irrevocable and preventing the insured from having any control over the life insurance policy, proceeds from the policy can pass the the person’s heirs in a tax efficient manner.
Many estate planning attorneys recommend the Irrevocable Life Insurance Trust because it is perhaps the single most tax efficient technique available to the general population. Many are under the false assumption that the payout on a life insurance passes completely tax free to the beneficiary. While life insurance proceeds are paid out income tax free, it is subject to the federal estate tax. Additionally, the payout on a life insurance policy may be subject to estate and inheritance taxes in some states. This is why the ILIT is so important.
Whether a life insurance policy is subject to the federal estate tax is dependent upon how the policy is owned. Generally, if a person owns a life insurance policy on his or her own life, then the face value of that policy will be includible in the person’s taxable estate. Since the federal estate tax exemption has increased substantially, many people are no longer worried about the federal estate tax. The federal estate tax exemption is always subject to change though. In fact, it is scheduled to decrease by more than 50% beginning in 2026. If your estate is above the federal estate tax threshold, or you live in a state where there is a state estate tax or a state inheritance tax, an ILIT could substantially reduce the taxes that your heirs must pay.
Can an ILIT Can Own Assets Besides Life Insurance?
Yes. An ILIT can own property other than life insurance. Since the Settlor, the person establishing the trust, has very little control over the trust after it is established, funding an ILIT with assets other than life insurance is not right for everyone. Basically, once you put money into the trust, you are giving up the right to get the money back. However, your heirs can still be current beneficiaries of a Life Insurance Trust. Accordingly, the use of an ILIT can be a valuable asset protection tool for the right client.
An ILIT Can Be a Useful Part of a Special Needs Trust Plan
Here
When creating a Special Needs Trust, an ILIT is often an integral tool. For many people, they are willing to pay for the costs of a special needs child while they are alive. However, they also need to guarantee money will be available on their death. A Special Needs Trust within an ILIT is a way to guarantee that a special needs person’s needs are met in a tax efficient manner.
What is a Second to Die Life Insurance Trust?
A Second to Die Life Insurance Trust is designed to hold life insurance policy where both spouses are the insured. A second to die life insurance policy is typically less expensive than a policy on the life of just one person. Since the federal estate tax does not affect most people until the death of the surviving spouse, a Second to Die Life Insurance Trust is a great planning tool for many people.
