ILIT: Irrevocable Life Insurance Trust

What is an ILIT?

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.”

What is the Purpose of an ILIT?

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.

Irrevocable Life Insurance Trusts Pros and Cons

Pros:

Creditor/Divorce Protection for your Spouse: After your death the life insurance becomes cash. The ILIT can hold the money in a further, protective trust for your surviving spouse sheltering it from creditors and future spouses.
Creditor/Divorce Protection for your Descendants: The ILIT is an Irrevocable Trust, but at your death, it can continue as one more other Irrevocable Trusts. These trusts can protect your descendants from their legal entanglements, creditors, and divorces.
Reducing Death Tax Liability: Including avoiding state death tax at the second spouse’s death.
Keeping Assets within the Family: The ILIT can limit beneficiaries to your spouse and descendants. For example, life insurance to a son may end up with a daughter-in-law at his death, but an ILIT can make sure the life insurance passes to your grandchildren instead.
Special Needs Trust Planning: The ILIT can be drafted to provide care for a Special Needs Person without disqualifying that person from needs-based government benefits.
Sheltering Cash-Value Insurance: While in some states, the cash value in your life insurance can be seized by creditors. An ILIT can provide shelter.
Dynasty Trust: An ILIT can be set up as a Dynasty Trust, providing care for you descendants forever.
Privacy: An ILIT is not part of your probate estate, so it will not be publicly listed.
An ILIT can be designed to avoid future state income taxes.
Divorce Planning: An ILIT can hold life insurance subject to a divorce agreement and name both spouses as trustees. In this way, both spouses control premium payment and beneficiary designations.
Avoid Probate Delays: With an ILIT, life insurance is available as soon as the policy pays out, avoiding delays due to a minor child or the estate being beneficiary.
Reducing Executor’s Fees: If the life insurance pours into the estate, the executor may receive a higher fee. Life insurance in the ILIT is not part of the Probate estate, so the executor receives no fee based on its value.
Buy/Sell Agreements: An ILIT often is part of a buy/sell agreement, providing a clear roadmap for quick exchange of life insurance proceeds for the company shares.

Cons:

Loss of Control: The ILIT will own the policy, not yourself. For most people, this is not much of an issue, as the life insurance benefits arrive after your death.
Cost: though not terribly expensive, crafting an ILIT to your specific needs and situation does take time, so there will be some expense.
Need for Keeping Up With the Law: The law is always changing, and nothing is guaranteed. Techniques that work today may not work tomorrow. Over the years you will have to keep up with changes to make sure the ILIT is still providing the advantages you had hoped to gain.

Example:

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.

Typical Estate Questions About Irrevocable Life Insurance Trusts:

Here are some questions clients, beneficiaries, and Trustees ask:

Why should I create a Trust for a Life Insurance Policy?

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.

Can I put money from a Life Insurance Policy into a Trust?

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.

How long can an ILIT be active?

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.

Can a beneficiary to the ILIT also be the Trustee?

Yes. We should carefully examine each Trustee’s potential exposure for divorce and creditors, but having a beneficiary as the ILIT Trustee is possible.

How does an ILIT reduce death taxes?

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.

Is an ILIT private or public?

ILIT terms are not exposed to the public. An ILIT is private.

How does an ILIT avoid state income taxes?

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.

Can an ILIT beneficiary be a minor?

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.

Do I need to change my Life Insurance Beneficiary Form with an ILIT?

The life insurance policy must be transferred into the ILIT. Once the ILIT owns the policy, the trustee changes the beneficiary to the ILIT.

Can I have part of my Life Insurance go into the ILIT and part to someone else?

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.

Is there a minimum or maximum dollar amount required for an ILIT?

No, the ILIT can hold a policy of any size.

Can an ILIT avoid Inheritance Tax?

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.

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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.

Peter Klenk is the founding member of Klenk Law, a seven attorney boutique estate planning law firm. We serve clients in Pennsylvania, New Jersey, New York, Minnesota and Florida. Peter Klenk received his Masters in Taxation LL.M. from NYU Law School and his J.D. from the University of Minnesota Law School. He served his country in the Navy JAGC during Desert Storm. Easy to talk to, feel free to call Peter for an appointment. We will make the process as easy as possible!

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ILIT: Irrevocable Life Insurance Trust: Everything You Need to Know