Introduction
An irrevocable life insurance trust (ILIT) is a legal arrangement that allows individuals to protect their life insurance policies from estate taxes and ensure that the proceeds are distributed according to their wishes. By placing the life insurance policy into an irrevocable trust, the policyholder relinquishes ownership and control over the policy, but gains certain tax advantages and control over the distribution of the proceeds.
Benefits of an Irrevocable Life Insurance Trust
Estate tax reduction: One of the primary benefits of an ILIT is the reduction or elimination of estate taxes. When a policyholder owns a life insurance policy, the death benefit is included in their taxable estate upon their passing. By transferring ownership of the policy to an ILIT, the death benefit is no longer considered part of the estate, potentially reducing the overall estate tax liability.
Control over distribution: Another advantage of an ILIT is the ability to control how the life insurance proceeds are distributed. The policyholder can specify the beneficiaries and the terms under which the funds are distributed. This can be especially useful in situations where the beneficiaries are minors or individuals who may not be capable of managing a large sum of money.
Protection from creditors: Assets held in an ILIT are generally protected from the policyholder’s creditors. By removing the life insurance policy from their personal assets, it becomes more difficult for creditors to access the proceeds.
Preservation of government benefits: If the policyholder or their beneficiaries are receiving government benefits based on their income or assets, placing the life insurance policy in an ILIT can help preserve those benefits. Since the policy is no longer considered part of the individual’s assets, it does not impact their eligibility for government assistance programs.
Setting Up an Irrevocable Life Insurance Trust
Selection of trustee: The first step in setting up an ILIT is selecting a trustee. The trustee is responsible for managing the trust and distributing the proceeds according to the terms outlined in the trust agreement. It is important to choose a trustee who is trustworthy, financially responsible, and capable of fulfilling their fiduciary duties.
Creation of trust agreement: Once a trustee is selected, a trust agreement must be drafted. This document outlines the terms of the trust, including the beneficiaries, distribution instructions, and any specific provisions or conditions.
Transfer of ownership: The next step is to transfer ownership of the life insurance policy to the ILIT. This typically involves changing the ownership and beneficiary designation of the policy to the trust. It is important to follow the proper procedures and notify the insurance company of the transfer.
Annual gifting: To fund the ILIT, the policyholder can make annual gifts to the trust. These gifts are subject to the annual gift tax exclusion, which allows individuals to gift a certain amount each year without incurring gift tax. The trustee can then use these funds to pay the premiums on the life insurance policy.
Conclusion
In summary, an irrevocable life insurance trust (ILIT) is a powerful estate planning tool that offers numerous benefits. By removing the life insurance policy from the policyholder’s taxable estate, an ILIT can help reduce estate taxes and ensure that the proceeds are distributed according to the policyholder’s wishes. Additionally, an ILIT provides protection from creditors, allows for control over distribution, and can help preserve government benefits. Setting up an ILIT involves selecting a trustee, creating a trust agreement, transferring ownership of the policy, and making annual gifts to fund the trust.
References
– irs.gov
– investopedia.com
– legalzoom.com
