ILITs (Irrevocable Life Insurance Trusts) Pros and Cons
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An irrevocable life insurance trust is an estate planning tool that can help you reduce your taxable estate and avoid federal estate taxes.
How do ILITs work?
An irrevocable life insurance trust (ILIT) is a trust that is set up to own a life insurance policy on the life of the person who sets up the trust (the grantor). Once the trust is established, the grantor cannot make changes to the trust or access the policy’s cash value. This is why it’s called “irrevocable”.
The main purpose of setting up an ILIT is to remove the life insurance policy from the grantor’s estate for estate tax purposes. This can help reduce the amount of estate taxes that will be owed upon the grantor’s death. The policy’s death benefit is paid directly to the trust, which then distributes the proceeds to the trust’s beneficiaries.
To set up an ILIT, the grantor typically transfers ownership of the life insurance policy to the trust, which then becomes the policy’s owner and beneficiary. The grantor can make annual gifts to the trust to help pay the premiums on the policy. These gifts are subject to gift tax rules and may require the filing of a gift tax return.
The trustee of the ILIT is responsible for managing the policy and ensuring that the premiums are paid. The trustee can also make distributions to the trust’s beneficiaries, which are usually specified in the trust document. The beneficiaries typically receive the policy’s death benefit income-tax-free.
It’s important to note that once an ILIT is established, the grantor cannot make changes to the trust or access the policy’s cash value. This can be a disadvantage if the grantor’s financial situation changes and they need the funds. Therefore, it’s important to carefully consider the pros and cons of setting up an ILIT and to work with a qualified estate planning attorney to ensure that the trust is set up properly.
Tax Advantages of ILITs
One of the main benefits of an irrevocable life insurance trust (ILIT) is that it can help reduce the amount of estate taxes that will be owed upon the grantor’s death. When a person dies, their estate may be subject to federal estate taxes and/or state inheritance taxes, depending on the value of the estate and the state in which they live. These taxes can be quite substantial and can take a significant portion of an estate’s assets.