Life Insurance Trusts

Irrevocable Life Insurance Trusts (ILITs) are trusts that hold life insurance policies and receive the death benefits. When properly established, the policy value and the death proceeds stay out of the decedent’s estate. This provides liquidity to pay the federal estate tax and other costs of estate administration. Because the ILIT remains outside of the decedent’s estate, it is not subject to death taxes. The ILIT usually does not pay income taxes, either. However, once established, no one can change the provisions of the ILIT.

When is an ILIT Advisable?

Federal estate taxes may apply to persons with a high net worth. The bill can be sizeable due to the rates reaching 50%.  The ILIT serves as an immediately available source of funds to pay this obligation. The family is not forced to sell assets to come up with the money to pay the taxes. The estate avoids sales commissions and the delays in disposing of large assets. In addition, because the policy premiums should cost less than the value of the death benefits, one pays the estate tax with discounted dollars. For married couples, an ILIT can help pay the federal estate tax not bypassed by the credit shelter terms of their living trusts.

How Does the ILIT Work?

The ILIT escapes death taxes because the decedent does not control the trust, own any of the policies, or enjoy any rights as a beneficiary. A Trustee other than the decedent administers the trust and owns the assets. This same Trustee is the beneficiary of all death proceeds and distributes the assets to those persons named in the trust.  The decedent is insured under the life insurance policies and funds the premium payments. When the decedent dies, the Trustee of the ILIT either buys assets from or makes a loan to the decedent’s estate. The Executor, in turn, uses the cash to pay the estate taxes or other costs of administration. If the death benefit is larger than the death taxes and settlement costs, then the ILIT specifies under what conditions the beneficiaries receive the excess amount.

How Are the Policy Premiums Paid?

The decedent, during his life, gives money to the Trustee to pay the policy premiums. To avoid gift tax, the annual payments may not exceed the number of beneficiaries of the ILIT times the $13,000 exclusion amount. Further, when the insured gives the yearly payments, the ILIT Trustee must provide notice to the beneficiaries that they have the right, for a limited time, to demand the Trustee to forward them the money instead of using it to pay the premiums. Once this withdrawal right, known as a Crummey power, expires, the Trustee then sends the premium payment to the insurer.

Deciding if an ILIT is Right for You

An ILIT requires attention and cost to work correctly. Each year the Trustee must collect money from the insured, send theCrummey notices, and pay the policy premiums.  Due to the ILIT’s irrevocability, once the insured departs with the money, he cannot get it back, nor can he change the beneficiaries. On the other hand, the ILIT can designate a responsible person to pay estate taxes with discounted dollars. An individual should carefully analyze their position and risk tolerance with an experienced attorney to decide if the ILIT is a good choice for his or her situation.