What is an Irrevocable Life Insurance Trust?
An irrevocable life insurance trust is a trust funded with the purpose of controlling one or more life insurance policies. The trust might be established to minimize the estate tax liabilities of the included policy or policies, or to protect the benefit for the named beneficiaries.
How irrevocable life insurance trusts work
An irrevocable life insurance trust, or ILIT, is a trust that’s essentially set in stone once it’s established. The grantor who establishes the trust can fund it via a gift, a loan, or some other means. Different funding methods get treated differently in the eyes of the IRS.
The grantor takes out a life insurance policy on themselves, but they name the ILIT as the policy owner and the beneficiary. Usually, the premiums on that policy get paid by the ILIT, which the grantor continually funds.
The ILIT gets managed by a trustee, and distributions from it go to named beneficiaries per the agreement of the trust.
Historic uses for ILITs
Before the passage of the Tax Cuts and Jobs Act raised federal estate tax exemption limits significantly, many people used ILITs as a way to minimize the tax liabilities imposed on their estates.
With current limits at an all-time high, this isn’t a concern for most people. But if that law sunsets or if your estate would exceed the current limit, putting a life insurance policy within an ILIT can ensure that the proceeds from it aren’t taxed as part of your estate.
To clarify, you don’t need to worry about your beneficiaries facing income taxes on the death benefit you leave them via a life insurance policy. Instead, the concern here is federal and state estate taxes as they come into play for sizeable estates.
Other benefits and uses for ILITs
While ILITs can serve as estate planning tools, even people without a significant estate to leave behind might choose to establish this type of trust.
For starters, the irrevocable nature of the trust ensures that once it’s established, the trust will function per the grantor’s wishes. This can guarantee that certain people get certain sums of money, regardless of issues like a divorce, legal action, or outstanding debts. It can give the grantor peace of mind knowing that their beneficiaries won’t end up in probate court. The trust document specifically outlines how and when the death benefit gets distributed and is generally iron-clad.
People may also establish an ILIT if they want to leave a sum of money to someone who doesn’t have the financial acumen necessary to best handle it. Some individuals establish an ILIT to benefit minors or adults with special needs, for example, with the trustee to guide distributions.