Understanding the Irrevocable Life Insurance Trust (ILIT)

What is an Irrevocable Life Insurance Trust (ILIT)?

An ILIT is a potent legal strategy that leverages life insurance to protect wealth for your beneficiaries, by transferring term or permanent life insurance policies out of your estate, thus protecting the proceeds from estate or gift tax.

A Quick Overview

Tax benefits: The use of an ILIT transfers the proceeds from your life insurance policies outside of your taxable estate, thus minimizing or eliminating estate and/or gift taxes.

Creditor protection: It can shield assets from creditors upon your passing.

Streamlined distribution: Provides an efficient, direct and clear route for the distribution of benefits.

How It Works

An ILIT is an irrevocable trust, and involves the Grantor, the Trustee(s) and the beneficiaries. The Grantor will create and initially fund the trust, by transferring or buying a policy into the ILIT. The Trustee (usually not the Grantor) will manage the trust. The beneficiaries will receive the distributions from the trust.

Typically, the proceeds from a life insurance policy are taxable to the owner/insured in their gross estate. It is not uncommon to see clients with millions in life insurance, which can result in significant estate tax exposure. However, by placing life insurance policies in an ILIT, those proceeds are removed from the estate of the Grantor, thus reducing the taxable estate and potentially shielding millions from estate tax.

In addition, a taxable estate can be further reduced by the Grantor using their annual gift tax exclusion ($18,000 in 2024) to make additional contributions to the trust each year, which are then used to pay the premiums on the policy.

Once the Grantor passes away, the proceeds from the policy will be paid to the trust, and will be distributed in accordance with the terms of the trust.

Added Benefits of an ILIT

Protecting the Kids

Without planning, beneficiaries of a life insurance policy will receive their distribution all at once. While this may be ok for some, others may not do well with a large lump sum inheritance. Children would be a good example. With an ILIT, the Grantor (often the parent) can make a plan for staggered distributions to the kids, as well as include various stipulations on when a beneficiary is entitled to funds.

Governmental Benefits

Another benefit of using an ILIT is that it can protect beneficiaries who need access to governmental benefits, such as Medicaid. By not making the distributions directly to the beneficiary, and by careful management on the part of the Trustee, they can maintain their benefits.

Blended Families

It can be complicated to balance the needs of blended families. One of the strategies which can be used to safeguard children from previous relationships is to make them the beneficiary of an ILIT. Avoid those uncomfortable conversations with new spouses about splitting assets between new and old kids by simply buying a life insurance policy that will stay in a standalone trust, free from interference, protecting a legacy for your kids.

Asset Protection

An ILIT can be useful for asset protection. Because the assets are in an irrevocable trust, and not directly in the name of the grantor or beneficiary, they are generally protected from creditors.

The Trade-Off

If ILITs seem too good to be true, they almost are. But they do actually require a little in return.

They are Irrevocable - Because the trust is irrevocable, the terms typically cannot be changed once the trust is created. Anything placed in the trust cannot be taken out of the trust, except to be distributed to the eventual beneficiaries. The Grantor must give up control of the policy in order to take advantage of the benefits of an ILIT.

Choose Wisely - There are quite a few important administrative considerations with an ILIT, thus the choice of Trustee is very important. A professional or corporate trustee is worth the potential expense, so that an ILIT can properly take advantage of all potential tax benefits.

Up Front Cost - There are initial establishment costs, as well as potential ongoing administrative fees.

But when juxtaposed against the potential savings and the sanctity of your heirs’ inheritance, these can be relatively minor considerations in the grand scheme of things. In a world where the only certainty are death and taxes, the least we can do is prepare for their intersection with proactive strategic intent. With the right legal advisor, the ILIT could be a powerful tool in your estate plan. If you would like to discuss the Irrevocable Life Insurance Trust further, please give me a call at (614) 408-0529 or reach out to info@LBesq.com.