What is an Irrevocable Life Insurance Trust (ILIT)?
An Irrevocable Life Insurance Trust (ILIT) can be an important tool in a comprehensive estate plan. An ILIT is a trust created during an insured’s lifetime that owns and controls a term or whole life insurance policy. The trust will also manage and control the distribution of the proceeds that are paid out upon the insured’s death.
There are several roles within an ILIT: the grantor, trustees, and beneficiaries. The grantor is the one who typically creates and funds the ILIT. Transfers and gifts to the ILIT are permanent and the grantor is giving up control to the trustee. The trustee will manage the ILIT and the beneficiaries will receive distributions.
Should an ILIT be part of your estate plan?
One of the biggest reasons ILITs are utilized is to minimize the estate tax. If you are the owner and insured of a life insurance policy then the death benefit of the life insurance will be included in your gross estate which is used to calculate any state or federal estate taxes that may be due at the time of your death. Conversely, life insurance owned by an ILIT will remove the death benefit from your gross estate and therefore not subject to state and federal estate taxation.
A properly drafted ILIT will also avoid gift tax consequences since contributions by the grantor are considered gifts to the beneficiaries. To avoid gift taxes, the trustee of the ILIT must notify beneficiaries of the trust that they have a right to withdraw a share of the contributions for 30 days. Generally, the beneficiary will not exercise their right to withdraw and after the 30-day period has lapsed, the trustee can pay the premium of the policy. It is imperative that a trustee of an ILIT completes this each time policy premiums are paid and that they understand the importance of completing this properly.
The ILIT will also allow you to control how the proceeds from the life insurance will be distributed to your beneficiaries. For example, the grantor can set up sub-trusts so the proceeds will be disbursed as they desire for that specific beneficiary’s unique circumstances. For example, if a beneficiary has creditors or financial maturity concerns, a sub-trust can be created so that a trustee manages the distribution to the beneficiary and the inheritance would be protected from any of the beneficiary’s creditors.
While an ILIT can provide significant benefits to your estate and tax planning, it is important to be aware that any policy being transferred that has a large accumulated cash value will result in a gift at the initial time the trust is funded. Any gift made above the annual gift tax exemption will require a gift tax return filed with the IRS.
Your estate planning attorney can discuss if an ILIT would fit your unique estate and tax planning goals. The team at Sinclair Prosser Gasior can also help prepare any gift tax return that may be required.
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