An irrevocable life insurance trust (ILIT) is a special trust that allows for the possible exclusion of life insurance proceeds from the estate tax. Such an irrevocable life insurance trust, by definition, is unchangeable - a key drawback of its establishment. Yet an ILIT’s potential enormous estate tax savings, particularly for those with large life insurance policies and high net worths, might make an irrevocable life insurance trust something worth contemplating.
The Most Important Irrevocable Life Insurance Trust Consideration
Since the primary purpose of an ILIT is estate tax reduction, consider if and to what extent you will be exposed to the estate tax. Since the estate tax rules undergo frequent changes and your net worth itself may fluctuate over time, you may need to periodically revisit a previous decision to forgo an ILIT. Note: life insurance proceeds are explicitly excluded from income taxes.
Marital Exclusion
Although the amount an individual can exclude from the estate tax changes from time to time due to Congressional legislation, surviving spouses who are U.S. citizens receive an unlimited marital deduction. Therefore, no estate tax will be due on any life insurance proceeds paid to the spouse of the person who dies. However, when the surviving spouse passes away, any remaining proceeds, which could be substantial, will be included in his/her estate.
Setting Up an Irrevocable Life Insurance Trust
You’ll need to work with an attorney to set up an irrevocable life insurance trust. Ideally, you’ll select a lawyer who specializes in estate planning. In order to draft the trust document and put your estate plan in place, you must make several decisions including:
- Who will be the trustee of the trust?
- Who will be the beneficiary of the life insurance proceeds?
- Will you be buying a new life insurance policy inside the trust or will you be transferring an existing policy?
Once you make these decisions, they are not changeable. (Compare an ILIT to a revocable living trust.) With an irrevocable living trust, you lose virtually all flexibility. On the other hand, as long as you live at least another three years after you transfer a life insurance policy to the ILIT (no minimum longevity is required for policies the trust itself purchases), all of your life insurance proceeds will pass outside of your estate, potentially saving your estate a sizable estate tax.
