Irrevocable Life Insurance Trust: What it is & its Benefits
By: Larissa A. Mehlfelder, CFP®, CAIA, BFA™
When you own life insurance, whether it's a temporary or permanent policy, the death benefit is included in your taxable gross estate. Alternatively, if the policy is owned by an Irrevocable Life Insurance Trust (ILIT), the death benefit proceeds are not included in your gross estate and therefore are not subject to state and federal estate taxation. For some people, this may not matter if their estate is below estate tax exemption levels. As of 2022, the federal exemption level is over $12 million per person or $24 million for married couples. However, that is currently scheduled to sunset in 2025 and be cut in half to over $6 million per person, or $12 million for married couples. Different states have varied estate tax exemption levels as well.
While estate taxation may not be an issue for your family today, it could be down the road as tax policies change. You may want to consider incorporating an ILIT into your financial plan to help offset future estate taxes and allow for more efficient wealth transfer to your heirs.
What Is an Irrevocable Life Insurance Trust (ILIT)?
An ILIT is established during your lifetime by purchasing a life insurance policy or transferring an existing policy into a trust, which becomes the policy’s owner. Note that if you go the route of transferring a policy, there is a three year look-back rule. This means that if you were to die within three years of transferring the policy into the trust, your policy will be pulled back into your estate upon your death. You will then name beneficiaries of the trust, such as your spouse, children, grandchildren, or their spouses. Upon your death, the ILIT will receive the life insurance policy’s death benefit and distribute proceeds to the named beneficiaries.
You must also name a trustee when setting up the ILIT — you can’t serve as the trustee yourself. This can be a family member, a close friend, an attorney, or someone else you trust. Choose your trustee carefully because this person will be responsible for managing the trust while you are alive as well as distributing the death benefit proceeds and trust assets after you pass away.
You can give your trustee authority to control when beneficiaries receive death benefit proceeds. For example, they can be distributed when beneficiaries reach the age of majority, graduate from college or reach some other life milestone, like getting married and starting a family. Alternatively, proceeds can just be paid out to your beneficiaries in full upon your death.
The biggest drawback of an ILIT is that, as the name implies, it is irrevocable. In other words, no changes can be made once the trust is finalized. Any assets that you, as the grantor, place in the trust no longer belong to you and you have no control over them.
Funding Alternatives for ILITs
ILITs can be either funded or unfunded:
In a funded trust, you will transfer other property into the trust in addition to life insurance — this may be cash, securities or other assets that will be used to pay future life insurance premiums.
If the ILIT is funded and those assets are invested and generating taxable income, it is possible that the income would be taxable to you as the grantor instead of taxable to the trust itself. Investors may choose this approach as a way to reduce their taxable estate further.
In an unfunded trust, there is no other property in the trust besides the life insurance policy itself. Therefore, future annual gifts must be made from you, the grantor, to help pay future life insurance premiums.
Since the ILIT owns the life insurance policy, it will make the premium payments each month or year. As the grantor, you will deposit money into the trust to make premium payments. These funds are classified as gifts to the beneficiaries. For them to be considered tax-free gifts that count toward the $16,000 annual gift tax exclusion (as of 2022), beneficiaries must receive a letter giving them what’s known as “Crummey powers.”
This letter will inform the beneficiaries that a gift has been made to the trust and they have the immediate and unrestricted right to withdraw the money within a certain time period (usually 30 days). The Crummey letter essentially changes what would be a future gift into a present gift by giving the beneficiary an immediate and present interest in it. This allows the gift to qualify under the gift tax exemption to the extent that it’s less than $16,000 per beneficiary.
The idea, of course, is that beneficiaries will not withdraw these funds but that they remain in the trust to pay the life insurance premiums. However, a Crummey letter must be sent telling the beneficiary that they have the right to withdraw the money for the money to count toward the annual gift tax exclusion.
Additional Benefits of an ILIT
An ILIT offers other potential benefits in addition to eliminating or reducing estate taxes:
- Cash is available to help pay estate settlement costs and meet other liquidity needs.
- Probate costs can be avoided on life insurance proceeds and any other assets held in the trust.
- Trust provisions are a not a matter of public record — they are private and confidential.
- Assets in the trust are shielded from creditors’ claims at the time of the grantor’s death.
- Income is provided to heirs and survivors, giving them greater financial security.
How A Financial Advisor Can Help
A Simon Quick advisor can answer your questions about irrevocable life insurance trusts and help you decide if establishing one makes sense for you. To learn more, call us at (973) 525-1000 or send an email to email@example.com.
About Larissa Mehlfelder
Ms. Mehlfelder joined Simon Quick in June 2009 with prior experience in wealth management and investing. As a Client Advisor based in Morristown, NJ, she works with clients in developing and implementing their financial planning objectives. Throughout her wealth management career at other boutique financial advisory firms, she has gained valuable experience monitoring client investments and spearheading strategic marketing efforts. Ms. Mehlfelder earned a BS degree in Finance with a minor in Mathematics from The College of New Jersey where she maintained Dean’s List status. She completed Fairleigh Dickinson University's Program for Financial Planners in 2011 and became a CERTIFIED FINANCIAL PLANNER™ practitioner in 2012. She earned her CAIA Charter in March of 2014 and is a member of the Chartered Alternative Investment Analyst Association. To learn more about Larissa visit her LinkedIn
This information is for general and educational purposes only. You should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from Simon Quick Advisors & Co., LLC (“Simon Quick”) nor should this be construed as an offer to sell or the solicitation of an offer to purchase an interest in a security or separate accounts of any type. Asset Allocation and diversifying asset classes may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Investing in Liquid and Illiquid Alternative Investments may not be suitable for all investors and involves a high degree of risk. Many Alternative Investments are highly illiquid, meaning that you may not be able to sell your investment when you wish. Risk of Alternative Investments can vary based on the underlying strategies used.Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Simon Quick), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Simon Quick is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. If you are a Simon Quick client, please remember to contact Simon Quick, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. Simon Quick Advisors, LLC (Simon Quick) is an SEC registered investment adviser with a principal place of business in Morristown, NJ. Simon Quick may only transact business in states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of our written disclosure brochure discussing our advisory services and fees is available upon request. References to Simon Quick as being "registered" does not imply a certain level of education or expertise.This newsletter and the accompanying discussion include forward-looking statements. All statements that are not historical facts are forward-looking statements, including any statements that relate to future market conditions, results, operations, strategies or other future conditions or developments and any statements regarding objectives, opportunities, positioning or prospects. Forward-looking statements are necessarily based upon speculation, expectations, estimates and assumptions that are inherently unreliable and subject to significant business, economic and competitive uncertainties and contingencies. Forward-looking statements are not a promise or guaranty about future events.Economic, index, and performance information herein has been obtained from various third party sources. While we believe the source to be accurate and reliable, Simon Quick has not independently verified the accuracy of information. In addition, Simon Quick makes no representations or warranties with respect to the accuracy, reliability, or utility of information obtained from third parties.Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices or benchmark index, as comparative indices or benchmark index may be more or less volatile than your account holdings. You cannot invest directly in an index.Indices included in this report are for purposes of comparing your returns to the returns on a broad-based index of securities most comparable to the types of securities held in your account(s). Although your account(s) invest in securities that are generally similar in type to the related indices, the particular issuers, industry segments, geographic regions, and weighting of investments in your account do not necessarily track the index. The indices assume reinvestment of dividends and do not reflect deduction of any fees or expenses.Please note: Indices are frequently updated and the returns on any given day may differ from those presented in this document. Index data and other information contained herein is supplied from various sources and is believed to be accurate but Simon Quick has not independently verified the accuracy of this information.