Life Insurance, Meet Your Estate Plan - The ILIT
Most people may not realize that the amount exempt from taxes when you die (currently set at $5.45 million) includes the proceeds from their life insurance policies. For example, a $1 million life insurance policy means that upon death, if you own anything that exceeds $4.45 million, you will be subject to a very high estate tax (40%).
This can be avoided by forming an “irrevocable life insurance trust,” or ILIT (pronounced “eye-lit”).
In short, the ILIT owns your insurance policies for you and keeps the proceeds out of the estate tax exemption. The trade-off? You must give up ownership of your ILIT, or any right to change its terms, once it’s created - which may not be a bad thing.
The three components to an ILIT are the grantor (i.e. you); the trustee, who manages it; and the beneficiaries who get the insurance proceeds when you die.
Because you are the grantor, you can’t serve as trustee (i.e. manager) since this would give you “ownership” of the ILIT. But your spouse, adult children, financial institution or attorney can act as trustee, as long as they are not also the beneficiary of the trust. You can name any person or organization you wish as the beneficiaries of your ILIT. Most people name their spouse, children and/or grandchildren.
To pay the policy premiums, you gift money or other assets to the trust, which in turn pays the premiums. Using assets and their resulting income to pay your premiums has the added benefit of any future appreciation being also sheltered from estate taxes.
The ILIT can be designed to distribute the life insurance proceeds immediately, or, to hold/manage them for a period of time before being distributed - a good option if you are worried about the funds being used irresponsibility.
Keep in mind the three-year rule: if you die within three years after transfer of your insurance into an ILIT, the insurance is essentially removed from the ILIT, and added back into your estate for taxation purposes. So it is generally advisable to establish an ILIT first and then have the ILIT purchase the policy directly, instead of purchasing the policy in your own name.
For an ILIT to work according to your wishes, careful selection of the actual policy as well as proper drafting of the trust document is essential. If you are interested in establishing an irrevocable life insurance trust, we would be happy to speak with you.