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Should You Consider an Irrevocable Life Insurance Trust (ILIT)?

Life insurance is often one of the first investments people consider when they begin estate planning. The right policy can help cover certain expenses for your beneficiaries after you pass. However, choosing the right life insurance policy for you and your family can be a difficult and confusing process. Policies vary widely in their terms. Whether the policy has a guaranteed payment, whether you have access to the value during your life, the length or duration of the policy if there are coverage requirements, and the amount paid to your beneficiaries are all considerations.

Irrevocable life insurance trusts—or “ILITs”—have been a popular choice for certain families, especially those who hold larger life insurance policies. A properly drafted ILIT can not only help your family cover expenses after your death, but it is one way to move assets out of your taxable estate while offering protection for your beneficiaries.

Below, we will cover some of the basics about ILITs to help you determine whether this type of trust is right for you and your loved ones.

How Do ILITs Work?

An ILIT is a trust which is created to hold one or more life insurance policies on the life of an individual or on a couple. The ILIT owns the policy itself and, when the insured person dies, the trust receives the benefits, and the trustees either distribute to the beneficiaries directly or hold and invest the proceeds for future distribution. Because the insured person does not own the policy itself, the benefit may be excludable from the taxable estate.

While an ILIT can give individuals significant control as to how their life insurance policy is distributed, grantors should be cautious when establishing any irrevocable trust. Because an ILIT is irrevocable, changes are difficult to make. There are limited options to halt payments or change beneficiaries once the ILIT is the owner of the policy.

How Are ILITs Funded?

There are two methods to fund an ILIT: (1) the grantor transfers cash into the trust when it is created so that the ILIT is the purchaser of a new life insurance policy, or (2) the grantor transfers a life insurance policy he or she already owns into the trust. Each method has its own benefits and complications which should be considered and discussed with your estate planning attorney or financial advisor.

Because ILITs are linked with the life insurance policies they own, the trust can “fail” if premiums are not consistently paid. If the ILIT does not own other assets which can be used to pay premiums of the life insurance policy, grantors can make gifts to the trust periodically by transferring cash to the ILIT whenever premiums are due. A properly drafted ILIT can even use a portion of the grantor’s annual gift tax exclusion (up to $16,000 per individual beneficiary in 2022) to make these gifts without sacrificing any part of the grantor’s lifetime gift tax exemption.

When considering whether an ILIT is an option for you, remember to consider how you want to pay for and preserve the life insurance policy. These policies are often long-term commitments, and your options will involve planning around estate and gift tax issues, as well as the generation-skipping transfer tax (“GSTT”), which can all be discussed with an experienced estate planning attorney.

What Are Some Benefits of ILITs?

For those people who may have taxable estates, whether under Maryland or federal estate tax laws, a primary benefit of a properly structured ILIT is the opportunity to avoid estate taxes by removing the policy from the grantor’s estate. If a large life insurance policy would push your estate into this taxable territory, now or in the future, an ILIT may be a good option for you.

ILITs can also offer liquidity to cover taxes or administrative costs for estates that have difficult-to-sell assets such as significant real property, or closely-held family business interests. After receiving the policy proceeds, the trustees of the ILIT can choose to purchase assets from the estate or revocable trust at the asset’s fair market value, providing cash for estate taxes or other costs of administration. Additionally, an ILIT can balance or equalize distributions to your beneficiaries when you own these difficult-to-divide or sell properties. Some beneficiaries can inherit the real property or business interest from the estate or revocable trust whereas others can receive similar value out of the ILIT.

As with other irrevocable trusts, an ILIT can also protect assets from creditors and preserve wealth for your family and loved ones. Depending on how the ILIT is structured, and how a grantor has utilized or allocated their GSTT exemption, the trust can continue to benefit and be available to your family for generations.

Consult With a Professional

Before you decide on funding an irrevocable life insurance trust, be sure to schedule a consultation not only with an experienced estate planning attorney but also with a trusted insurance agent and/or financial planner.

If you have any questions on irrevocable trusts, life insurance planning, or how to establish and fund an irrevocable life insurance trust, do not hesitate to reach out to our office.

At Sessa & Dorsey, we consider the bigger picture at hand and advise our clients on the best estates and trusts for their specific needs and desires. If you have questions, please contact us at (443) 589-5600.

Related blog posts:

Understanding Grantor Retained Annuity Trusts (GRATs)
Best Practices for Irrevocable Trusts
Revocable vs. Irrevocable Trusts: Which is Right for Me?
The Top 5 Benefits of a Trust
Estate Planning 101: Who Should I Choose as My Trustee?