Irrevocable Life Insurance Trust
Irrevocable Life Insurance Trust (ILIT)
An irrevocable life insurance trust was designed to protect life insurance proceeds from estate tax. It is a contract created between the grantor and the trustee to administer an insurance contract for the benefit of named beneficiaries. Because it is irrevocable, the grantor cannot change, modify or amend in any way the trust. The grantor cannot reclaim ownership of the trust property or change the terms of the trust.
Benefits of an ILIT
- protects your policy’s cash value from yours and your family’s creditors
- Removes life insurance proceeds from your estate
- Probate avoidance
- Ability to control how the proceeds of your policy are paid out. For instance:
Without an ILIT
Typically without the benefit of the ILIT, your proceeds would be completely paid out to your beneficiaries upon your death. Some people may not find this an advantageous scenario especially with children who have not yet reached adulthood or for those who are prone to squandering their money.
With an ILIT
It is possible to control the payout of your proceeds using the happening of certain events as triggers for payouts. For instance, you could pay out half of your funds immediately and the remaining could be paid upon the happening of: 5 year anniversary of the grantor’s passing, sole beneficiary’s wedding, youngest beneficiary turning 30 years old.
How Life Insurance Trusts are Established
The ILIT is drafted and a trustee is named to administer it. Often, the grantor’s lawyer or CPA is named as the trustee. The trustee obtains a tax id number for the ILIT because he ILIT is a new taxpayer and must pay tax on it’s income. During the grantor’s lifetime, the trustee administers the trust and upon the grantor passing, the trustee holds or distributes the assets to the beneficiaries according to the trust.
The ILIT should be established before life insurance is purchased allowing the trustee to sign the insurance application listing the trust as the application, owner and beneficiary of the policy and the grantor as the insured. Owning the policy before transferring into the ILIT triggers the 3 year rule, which provides that if the grantor dies within 3 years of transferring an existing policy into the trust, the trust will be disregarded and the insurance proceeds will be subject to the grantor’s estate tax.
Little to no Gift Tax is incurred upon Creation of the Trust and Premiums Paid
Utilizing the annual gift tax exclusion amounts, gift splitting (where applicable) and Crummy withdrawal rights granted to each beneficiary premiums can be tax free or close to it.
When the trustee applies for life insurance on the insured, the trustee should take precaution if the insurance company requires a check with the application. If this is the case, the grantor(insured) should make an initial deposit to cover the initial premium, a checking account should be opened in the name of the trust using the tax id number and the trustee should notify the beneficiaries that a gift is being made to the trust and that they have the right of withdrawal. After the time for withdrawals has elapsed, payment to the insurance company may be made.
Influence decisions and behaviors of your Beneficiaries
Distributions may be conditioned upon the beneficiaries adoption or rejection of behaviors or characteristics. Also, the grantor may desire the beneficiaries to attain certain goals for which the beneficiaries may be rewarded with a distribution. Attempting to influence these decisions may be carried out through a Letter of Wishes delivered to the ILIT trustee that sets forth your philosophy concerning distributions.
