An ILIT is an Irrevocable Trust created specifically to hold life insurance policies.
The person who forms the trust is called the “Grantor,” and the individuals who benefit from the trust are the “Beneficiaries.” The Irrevocable Life Insurance Trust is nothing more than paper, so it needs a person to carry out its terms. That individual or entity is called the “Trustee.”
In the past, the primary goal of the ILIT was to avoid Death Taxes. But, it is a versatile trust and can serve many purposes including divorce planning, buy/sell agreements, blended family planning and more. Easy to form and readily recognized by the IRS, and ILIT makes up a portion of many estate plans.
If a Pennsylvania resident named his wife as beneficiary of his $1M life insurance policy, no Inheritance Tax is due at his death. But, at the wife’s death, the $1M is now cash subject to the tax. Before the children receive the $1M, a $45,000 tax is due. The ILIT avoids the tax entirely.
Here are some questions clients, beneficiaries, and Trustees ask:
Having life insurance owned by an Irrevocable Trust removes the life insurance from your taxable estate and shelters the proceeds. If you die, the trustee can quickly collect the funds, avoiding complications your beneficiaries or your estate might face. For example, you might die in a car accident in which spouse was driving. Your spouse might be subject to a lawsuit from other victims, so your life insurance proceeds might be subject to these claims. Further, if both of you have died and you have minor children, they are unable to collect the funds. An Irrevocable Life Insurance Trust avoids all these complications.
After you have collected the life insurance, it is too late to fund an ILIT, but there are other Irrevocable Trust options that we can explore. The trust most useful to you will depend on your particular situation and your overall Estate Plan.
The ILIT will exist until the insured’s death, but in some states such as Pennsylvania and New Jersey, the ILIT can then go on forever sheltering the proceeds from your descendants’ creditors and divorce.
Yes. We should carefully examine each Trustee’s potential exposure for divorce and creditors, but having a beneficiary as the ILIT Trustee is possible.
By removing the life insurance and the proceeds from your and your spouse’s taxable estate, they avoid the tax. For example, if a Pennsylvania resident places a $1,000,000 policy in an ILIT for his wife, at his death the $1,000,000 is not included in his estate. If the wife dies soon after and the $1,000,000 passes in further trust for the children, the cash is also not in the wife’s estate. This avoids $45,000 of Pennsylvania Inheritance Tax.
ILIT terms are not exposed to the public. An ILIT is private.
A Life insurance distribution is not subject to income tax. Further, if the ILIT is drafted to have a situs in a state without income taxes, the annual non-distributed income avoids state income tax. If the trust assets are being invested as a “nest egg” for a child’s retirement, in the long run avoiding state income tax can substantially increase that nest egg.
Yes, ILIT beneficiary’s are often minors. The Trustee uses the trust funds for the minor. The document can name an age when the minor becomes the trustee.
The life insurance policy must be transferred into the ILIT. Once the ILIT owns the policy, the trustee changes the beneficiary to the ILIT.
The ILIT must own the life insurance policy, so the ILIT is the beneficiary. But, you can have us draft the ILIT to say a certain amount immediately passes out to someone. For example, the trust could say the first $300,000 of life insurance passes outright to your parents while the remainder stays in the trust to provide for your children.
No, the ILIT can hold a policy of any size.
Yes, the insurance proceeds are not included in your estate and, if drafted properly, the proceeds will avoid inheritance taxes at the beneficiary’s death.
If you have any questions about Irrevocable Life Insurance Trusts or any other estate administration topics, please contact us to schedule a free consultation. For more than two decades Klenk Law has focused only on Estate Law. We’ve seen it all, and this experience allows us to explain complex estate law and planning techniques clearly and concisely. We make it easy for you to understand ILITs so you can make the best decisions for yourself and your family.
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