An Irrevocable Life Insurance Trust (ILIT) is a key estate planning tool that allows individuals to exclude life insurance proceeds from their taxable estate. This trust owns the life insurance policy rather than the individual, so when the insured person dies, the death benefits paid out by the policy belong to the trust, not the individual’s estate. This separation helps minimize estate taxes and protects the proceeds from creditors.
How Does an ILIT Work?
To set up an ILIT, the grantor—the person who creates the trust—transfers ownership of an existing life insurance policy or directs the trust to purchase a new policy. Because the trust is irrevocable, the grantor relinquishes any control or rights to the policy once the trust is established. This is important for ensuring the death benefit stays out of the taxable estate.
The ILIT is managed by a trustee, who follows the trust document’s instructions to distribute insurance proceeds to the named beneficiaries when the insured passes away. The grantor can specify exactly how and when these funds will be distributed, which helps with financial planning and asset protection for heirs.
Advantages of an ILIT
- Estate Tax Savings: The primary benefit of an ILIT is to remove the life insurance death benefits from the gross estate, potentially reducing estate taxes owed by heirs.
- Control Over Proceeds: The trust document can dictate the timing and conditions of payouts, helping ensure the funds are used as intended.
- Creditor Protection: Because the policy is owned by the trust, the proceeds can be shielded from the insured’s creditors.
- Flexibility: Although irrevocable, the trust can be structured to include various provisions, such as for minor children or special needs beneficiaries.
Important Considerations
- Irrevocability: Once the ILIT is funded and the trust owns the policy, the grantor cannot change or dissolve the trust without beneficiary consent.
- Gift Tax Implications: Transferring an existing policy or gifting cash to the ILIT for premium payments may have gift tax consequences and should be planned carefully.
- Three-Year Rule: To avoid including the death benefit in the estate, the insured must survive at least three years after transferring the policy to the ILIT, according to IRS rules.
How an ILIT Fits in Estate Planning
An ILIT is often part of a larger estate plan that may include wills, powers of attorney, and other types of trusts. This sophisticated tool helps manage wealth transfer efficiently, especially for larger estates that might be subject to federal or state estate taxes.
To create or fund an ILIT properly, it’s advisable to work with an estate planning attorney or financial advisor who understands the complexities involved.
For more on trust types, see our glossary entries on Irrevocable Trust and Estate Tax Planning. You may also find guidance on selecting beneficiaries helpful in Beneficiary.
Additional Resources
- IRS Publication 559 provides information on the tax treatment of trusts.
- Consult IRS guidelines specific to gift tax rules and estate taxes (irs.gov).
By using an ILIT appropriately, individuals can protect life insurance benefits from estate taxes, retain control over how proceeds are used, and help ensure a smoother transfer of wealth to loved ones.
