ILIT 101

All About Irrevocable Life Insurance Trusts

ILIT 101
February 11, 2016

An Irrevocable Life Insurance Trust (ILIT) is a trust set up to hold ownership of your life insurance policies. There are three primary reasons why an ILIT might be right for you.

  • Avoiding Estate Taxes – Unless you take steps to prevent it, the proceeds of your life insurance policies are included as part of your estate for determining estate taxes. This may not be an issue unless your estate is above the estate tax exclusion amount ($5.43 million for tax year 2015), but a large life insurance policy may put you near or over the threshold.

    By establishing an ILIT, ownership is transferred to the trust and the policy is no longer considered as part of your estate. The ILIT becomes the beneficiary of your life insurance policy, and your intended beneficiaries of the life insurance policy become the beneficiaries of the ILIT. Your beneficiaries are taken care of, and estate taxes are bypassed.

  • Asset Protection – An ILIT makes it extremely difficult, if not impossible, for creditors to access your life insurance assets in case of legal actions.

  • Regulation of Beneficiaries – If a beneficiary is a minor or has irresponsible tendencies such as gambling or drug use, setting up your life insurance through a trust can ensure that the trustee can regulate the assets per your wishes under the conditions set up in the trust document.

You cannot be the trustee, although you can make your spouse or children trustees. It is probably a cleaner break to choose someone else as a trustee, such as a bank or other financial institution, even if a fee is involved. Having family members as trustees could be construed as your “incident of ownership” over the policy that puts the policy back into your estate.

Usually ILITs are unfunded, where there is no other property included in the trust that can be used to make the premium payments. You, as the grantor, make transfers of cash to the trust during your lifetime to pay the premiums (you do not own the insurance anymore, so the payments must come through your trustee).

These premium payments will be considered as gifts to the ILIT and will be subject to gift taxes if the amount is above the annual gift tax exemption ($14,000 per beneficiary for tax year 2015). Lifetime limits also apply.

An important element of the ILIT is the Crummey powers granted to the trust beneficiaries. Named for a court case on the issue, Crummey powers allow beneficiaries the right to withdraw the annual cash transfers to the trust during a short window of time. Beneficiaries must be notified of this right. Of course, the point is for the beneficiaries to decline to withdraw the transfers and for the trustee to use the cash transfers for premium payments as intended — but just having the ability to do so allows the transfers to qualify for the gift tax exclusion.

You can also transfer an existing policy into an ILIT, but there is a three-year waiting period for the ILIT to take effect. Should you pass away during the waiting period, your insurance policy will still be subject to estate taxes. Consult a qualified professional and understand the ramifications of each path to avoid running afoul of tax laws.

Make sure that you understand all the ramifications of an ILIT before you enter into one, and seek qualified financial and legal professional guidance in putting the ILIT together. Remember that the first “I” stands for irrevocable, meaning once the ILIT is established, it cannot be undone or altered.

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  Conversation   |   40 Comments

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Elaine | 09.02.15 @ 17:02
I will definitely be seeking a qualified financial professional to help avoid this. Thanks for the info.
Erin | 09.02.15 @ 17:05
This is great information to have and definitely something I will be looking into. Thank you.
Chrisitna | 09.02.15 @ 17:10
This is a great reminder that as much as we hate to think about these things, they're so important!
Daniel | 09.02.15 @ 17:10
Life insurance choices can be daunting, using a pro to explain and ensure you have what you need is a major plus.
Kamie | 09.02.15 @ 17:13
This is some interesting information, definitely a plus, but could be bad. But, I am not ready to set a life insurance plan on myself yet.
Heather | 09.02.15 @ 17:29
Some good information here! It's something you always dread thinking about, but it is something the needs to be done.
Britt | 09.02.15 @ 17:30
Lots of wonderful information, as always. Picking the right life insurance company just seems so... trying.
Nancy | 09.02.15 @ 17:36
I had no idea that this even existed. Thanks for the information.
gracie | 09.02.15 @ 17:39
It's a tough thing to think about and plan. There were some things in here worth thinking over and discussing!
Zanna | 09.02.15 @ 17:41
I know this information will be useful, and I am sharing it with some family members who need to plan too!
Christina | 09.02.15 @ 17:44
Good information. I'll be looking more into this.
Rychana | 09.02.15 @ 17:52
This is a great article. You don't really think about these issues until it is too late.
Steffanie | 09.02.15 @ 18:17
Great information.
Carla | 09.02.15 @ 18:20
I had no idea that buying life insurance had so many aspects. Thanks for the information.
Sarah | 09.02.15 @ 18:28
This is really good information, broken down in a way that is easy to understand. I will be sharing this with a few people.
Angie | 09.02.15 @ 18:44
Glad to read about this - I didn't even know that this was a possibility.
Alec | 09.02.15 @ 18:50
I'm not planning on setting a life insurance policy up yet, but this seems like it may be a good option when the time comes. I'll be seeking the help of a professional about all my options to make sure my family gets every penny they can.
Bobbie | 09.02.15 @ 19:05
I wonder how this is different from a living will trust, other than the irrevocable part. Is a life insurance trust something that can be included as part of a living will trust?
Jane | 09.02.15 @ 19:32
Basically, ILIT's are a way for individuals to bypass paying taxes on life insurance proceeds.
Jo | 09.02.15 @ 19:54
The tips on avoiding estates taxes is very interesting.
Meredith L | 09.02.15 @ 20:18
I have an elderly friend who is taking care of his estate. This is definitely going to come in handy to protect his assets.
Chelsey | 09.02.15 @ 20:24
I never knew this was a way to bypass the estate taxes. And another reminder as to why it is so important to have a knowledgeable financial advisor.
Crystal | 09.02.15 @ 20:54
Life insurance is an important decision and should be discussed with a professional.
Debbie | 09.02.15 @ 21:12
I had no idea we even needed this. I love the information, thank you.
trish | 09.02.15 @ 21:16
I had never heard of this before. Definitely going to keep this in my back pocket to bring up to a qualified financial adviser some day soon.
Wanda Langley | 09.02.15 @ 21:16
Good advice about consulting a qualified professional about this type of life insurance.
irene | 09.02.15 @ 21:21
I'm not really worried about my "estate" being worth over $5 million, but good to know in case I hit the lottery.
Victor | 09.02.15 @ 21:31
You have to be very careful with those things, this is very dangerous.
Andrea | 09.02.15 @ 22:40
Certainly not a life insurance that I would be interested in. Thanks for sharing.
Beverly | 09.02.15 @ 23:54
We are looking into setting up an ILIT actually, for some of the reasons listed. It's a smart way to go if you have any kind of finances to pass on.
Vaughn | 09.03.15 @ 01:44
This reminded me I need to get this squared away.
Ron | 09.03.15 @ 08:49
Given how fluid life experiences can be, I wouldn't be sure this would be a viable option, as I would want my family to do what is best for them after I am gone.
Crystal | 09.03.15 @ 11:54
Great info! Thanks!
Rindy | 09.03.15 @ 13:19
This was very informative. I know a bit about insurance, but did not know about this type of life insurance.
Jackie | 09.03.15 @ 15:36
An interesting way to bypass estate taxes.
Morgan | 09.03.15 @ 16:51
Life insurance really is one of those tricky things to deal with, because you obviously want what is best and can be secured for your family.
Sara | 09.03.15 @ 17:31
Very good information. Always consult a professional before doing anything. Always want to make sure you have what you need and not a bunch of useless stuff.
STOKES | 09.03.15 @ 17:33
Good information. I don't know that my estate is valuable enough to need a ILIT, but it's information I could pass on to people who could use it.
Jill | 09.03.15 @ 17:52
I can't wait to share this with all my friends and family! Who knew?
Jo Ann | 09.03.15 @ 18:14
Nice to know there is a loophole to keep Uncle Sam's hand out of the life insurance money for your family. People need to remember that once this is set up, though, there is no undoing it, so make sure to educate yourself with the help of a qualified financial advisor, and a good estate planning attorney.
$commenter.renderDisplayableName() | 11.24.20 @ 12:57