When it comes to life insurance for estate planning, there are a number of options to consider. Developing a strategy to leave your family and loved ones best prepared and to keep life insurance proceeds safe from estate taxes can be complex or relatively simple, depending on your individual circumstances. Not having an estate plan at all can have a tremendous cost to heirs or beneficiaries.
Irrevocable Life Insurance Trust
One estate planning strategy that is growing rapidly in popularity and fits many situations well is an Irrevocable Life Insurance Trust.
Like most trusts, an Irrevocable Life Insurance Trust, or ILIT, is simply a holding device. It’s not a separate legal entity like a business. Instead, the trust holds an asset or multiple assets for the benefit of the beneficiary. A Trustee manages the trust, but with an ILIT, management of the trust usually doesn’t require much more than forwarding premium invoices or important correspondence to the insured.
The ILIT owns your life insurance policy for you, removing it from your estate. Because the trust owns the life insurance policy instead of you, the policy is not counted among your assets when the state or federal estate taxes are calculated. Additionally, by owning the policy, the ILIT protects the cash value of the life insurance policy from creditors. In some states, creditors can seize the cash value of a life insurance policy owned by you to satisfy a claim.
Depending on the state you live in and the amount of the federal estate tax exemption, which seems to change every year, the savings realized by sheltering the proceeds of your life insurance policy from estate taxes can be significant. In fact, because estate tax and inheritance tax laws change so often, a trust can seem like the only safe way to ensure the proceeds of your life insurance policy go to whom you intended.
As its name suggests, the ILIT is—you guessed it—irrevocable. That means once you’ve created it and placed an insurance policy inside it, you can’t take the policy back in your own name.
What you can do is closely control many other aspects of it. For example, you can determine who your initial beneficiaries will be and you can define precisely how and under what terms they will receive any benefits. You can also choose the Trustee or Trustees who will manage your ILIT. While with many types of trusts it’s fine for you and your spouse to be the Trustee(s), you’ll want to choose an outside Trustee because otherwise, the IRS could deem that the proceeds of your life insurance policy never left your estate.
An ILIT provides you, your family, and your estate with considerable advantages—like tax-free life insurance proceeds. But these benefits can only be realized if the ILIT is properly designed and specific guidelines are met.
An experienced attorney will help you:
- Name your beneficiaries.
- Name your Trustees. Your Trustee will receive correspondences regarding the trust, responding or taking action, if needed, even if you are the one paying the premiums.
- Lay out the circumstances in which you’ll want your beneficiaries to receive money from the ILIT.
- Understand the rules of an ILIT in your state.
Before purchasing a life insurance policy, consult with an attorney regarding your potential income and estate tax consequences. If your estate is large enough, it could be subject to federal and state estate taxes, depending on what applicable law is in place at the time of your death.
You’ll also want to have your ILIT in place before binding the policy. An ILIT is a fairly simple trust but it will still require some time to set it up properly
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