Irrevocable life insurance Trust (ILIT)

An irrevocable life insurance trust (ILIT) is a trust that cannot be rescinded, amended, or modified, post creation. … Once the grantor contributes property or life insurance death benefits to the trust, he or she cannot change the terms of the trust or reclaim any of the properties held within.

Some people with large estates may be subject to federal or state estate taxes. While the federal estate tax exemption was substantially raised under the Tax Reform and Jobs Act, several states also have their own estate taxes with exemptions that are substantially lower. Some people do not realize that proceeds from their life insurance policies may factor into their estates and whether they might be subject to estate taxes. Thankfully, the professionals at Elder Care Direction can help you to understand ways to avoid the inclusion of your life insurance proceeds in your estate so that your family might not have to pay estate taxes out of your estate.

The Irrevocable Life Insurance Trust

One way to keep your life insurance proceeds from being included in your estate for tax purposes is to form an irrevocable life insurance trust or ILIT. This is a type of living trust that you can set up during your lifetime to own your life insurance policies. You are able to set up an ILIT and transfer your ownership of your existing life insurance policies to it after it has been formed. The trust can also buy life insurance policies to benefit your loved ones directly.
If you set up an ILIT, you are not allowed to serve as its trustee. It must be an irrevocable trust. This means that you must fund it by placing your policy under its ownership before you step aside. You must give up your right to change the ILIT or to dissolve it. If you served as the trustee, you would retain the incidents of ownership, which would give you control over the life insurance policy. This would mean that the proceeds would be included in your estate for tax purposes. Instead, you should name someone else to serve as the trustee. The person or organization that you choose to fill this role is up to your discretion.

What Are the Incidents of Ownership?

If you retained ownership of your life insurance policy, you would be able to withdraw cash value from it or to change the designated beneficiaries at any point in time. This would make it count as one of your assets, which would allow the IRS and your state�s taxing authority to include its proceeds in the value of your estate after you die.
If your estate is substantial, including your life insurance proceeds could make it vulnerable to the assessment of estate taxes. If you own the policy when you die, it will be included as an asset even though you have named someone else as the designated beneficiary.

Understanding Estate Taxes

Since the passage of the Tax Reform and Jobs Act, the federal estate tax exclusion has been substantially increased. Currently, it is set at $11.18 million for your estate. Your estate will only have to pay estate taxes on the values that exceed this threshold. However, your state might have a lower estate tax threshold, so you will want to check with your state to determine the exclusion amount.
Under federal law, an example of how your life insurance policy ownership might occur if you have property that exceeds $6.18 million and also have insured your life for $5 million or more. If you retain ownership of your life insurance policy in this scenario, your estate would have to pay estate taxes on any amount that exceeds the federal estate tax exclusion of $11.18 million. However, some states have much lower thresholds. If your state has a lower threshold, your estate might have to pay estate taxes even if the value of your estate is substantially lower than the federal threshold.

Who Are the Beneficiaries of an ILIT?

Normally, people name their ILITs as the primary beneficiary of their life insurance policies. When you die, the death benefits will be paid into your ILIT. The proceeds will be held in the trust to benefit the people who have been named as the beneficiaries of the trust. If you name your spouse as a beneficiary of the trust, he or she will receive regular payments instead of lump sums. This helps them to avoid being taxed on his or her own eventual estate as long as the money has not been depleted by the time that he or she dies.

Potential Complications of an ILIT

If you pass away within three years after you have transferred ownership of your life insurance policies to an ILIT, the proceeds will still be included in your estate by the IRS for determining estate taxes. This can be avoided by having your trust purchase the policy on your life. You can then fund the trust with enough money to pay the premiums over the years
. Gift taxes can be another complication of an ILIT. When you give money to the trust to pay for the premiums of your life insurance policy, the payments can be considered to be gifts that might be subject to the gift tax exclusion limit.
To avoid this, you can have your trustee send the beneficiaries of your trust something that is called a �Crummey� letter every time that you transfer money to the trust. This letter informs your beneficiaries that they can request a share of the money within a specified time period. As long as the beneficiaries have an immediate right to ask for the money, the gift tax will not apply. It would make little sense for the beneficiaries to claim an immediate right to the money, however. If they take it now, the premiums would not be paid, causing the policy to lapse.

Dissolving the Trust

Normally, you are not allowed to dissolve an irrevocable trust once it has been established. However, since the trust must make ongoing premium payments to keep the ILIT in effect, you could effectively cancel an ILIT by ceasing making payments for the premiums.