Irrevocable Life Insurance Trusts: A Shield for Your Wealth
Life insurance is a valuable tool for financial protection, but it can also be a powerful estate planning vehicle. An Irrevocable Life Insurance Trust (ILIT) is a complex legal arrangement that can offer significant tax and estate planning benefits.
What is an Irrevocable Life Insurance Trust?
As the name suggests, an ILIT is a trust that cannot be modified or revoked once it’s established. The primary asset of the trust is a life insurance policy. The insured person (the grantor) is not the owner of the trust or the policy. Instead, the trust is the owner, and it names beneficiaries to receive the death benefit. When a life insurance policy is held within an ILIT, the proceeds from the policy are not considered part of the decedent’s estate for tax purposes, provided the trust is properly structured and the decedent does not retain any control over the policy. This means that the life insurance proceeds can be used to pay estate taxes or other expenses without increasing the taxable estate, thereby preserving more of the family’s assets
Key Benefits of an ILIT
- Estate Tax Reduction:
- The most significant benefit of an ILIT is estate tax reduction. When the insured person dies, the death benefit is paid directly to the trust, not the estate. This can help reduce the size of the taxable estate. In Oregon, the estate tax rates are 10-16% of assets exceeding $1 million.
- Example 1: If an individual has $2 million in total assets, $1 million of which is life insurance that is shifted into an ILIT, the total tax savings would be approximately $100,000.
- Example 2: If an individual has $5 million in total assets, $3 million of which is life insurance that is shifted into an ILIT, the total tax savings would be approximately $220,000.
- The most significant benefit of an ILIT is estate tax reduction. When the insured person dies, the death benefit is paid directly to the trust, not the estate. This can help reduce the size of the taxable estate. In Oregon, the estate tax rates are 10-16% of assets exceeding $1 million.
- Asset Protection:
- The trust’s assets are generally protected from creditors and lawsuits. This can be crucial for high-net-worth individuals who are exposed to potential liabilities or any person who worries about divorce, lawsuits, judgments, or creditors.
- Control Over Assets to Support Beneficiaries:
- The grantor can specify how the death benefit will be distributed to beneficiaries through the trust. This provides greater control over the inheritance process compared to a traditional life insurance policy. This allows support for beneficiaries to thrive, rather than enabling beneficiaries to pursue problematic spending trends or dangerous addictions.
- Flexibility:
- ILITs can be structured to meet specific needs and goals, such as providing income for beneficiaries or funding special needs trusts.
How Does an ILIT Work?
- Creation: The grantor transfers life insurance policies to the trust. Alternatively, cash can be transferred to the ILIT and then the Trustee can use those funds to purchase a new policy. The trust becomes the owner of the policies.
- Funding: The trust can be funded with additional assets, but the life insurance policies are typically the primary asset.
- Ownership: The grantor relinquishes ownership of the policies and has no control over the trust’s assets.
- Death Benefit: Upon the grantor’s death, the life insurance death benefit is paid to the trust, not the estate. The trust then distributes the proceeds according to its terms.
Important Considerations
- Irrevocability: Once established, the trust cannot be changed or terminated.
- Gift Tax Implications: Transferring life insurance policies to the trust may trigger gift tax consequences.
- Complexity: ILITs are complex legal instruments that require careful planning and administration.
- Cost: Establishing and maintaining an ILIT can be expensive, although the savings in estate tax may substantially outweigh the cost.
Consulting with Professionals
Due to the complexities involved, it’s essential to consult with estate planning attorneys, tax advisors, and financial planners when considering an ILIT. These professionals can help you determine if an ILIT is suitable for your specific circumstances and assist in creating a customized plan that aligns with your goals.
An Irrevocable Life Insurance Trust can be a powerful tool for estate planning and wealth preservation. However, it’s essential to carefully weigh the potential benefits and drawbacks before making a decision.
