The Basics of an Irrevocable Life Insurance Trust
Typically life insurance death benefits pass tax-free to beneficiaries but are includable in your estate if you own the policy. For most, the inclusion of life insurance death benefits in their estate at death doesn’t matter since the Federal Estate Tax Exemption is $5,340,000 for individuals and $10,680,000 for married couples in 2014. Not only that, but a spouse can leave an unlimited amount to a surviving spouse without any tax implications. But for those who have amassed a large estate, it is possible to use life insurance to leverage annual gifts and pass death benefits to beneficiaries tax –free and outside their estate by using an irrevocable life insurance trust (ILIT). Here is a simple explanation of how the strategy works.
How Does an Irrevocable Life Insurance Strategy Work?
They main goal of this strategy is to keep the death benefit out of your estate. This is accomplished by creating an irrevocable life insurance trust. In doing so, you are essentially giving up all control of the assets in the trust which does not make it taxable to your estate.
Once you have created an ILIT, you can now have the trust purchase a life insurance policy. Since the final distribution of the estate will happen after the second spouses passes away in most cases, a survivorship policy (sometimes called a second to die policy) is an effective type of policy to use for this strategy. You can use annual gifts to fund the policy and pay premiums in the years to follow. It should be noted that in order for the gifts to qualify for the federal annual gift tax exclusion, the trust must contain a Crummey provision. Simply put, the beneficiaries must be allowed the power to withdraw gifts for a certain period of time so that they have “present interest”. This is usually not an issue if everyone involved understands the primary long term goal of the trust.
Once the surviving parent passes away, the death benefit will be paid to the trust. If structured properly, the death benefit will pass outside of the estate assets to the beneficiaries. These funds can be used to pay estate taxes if due.
When Is This Strategy a Potential Fit?
- Your estate is likely subject to estate taxes.
- You would like to provide a tax-efficient inheritance rather than make gifts that beneficiaries can potentially spend today.
- You don’t mind giving up control over the funds you gift.
- You have an estate that is subject to estate taxes and is made up of real estate, a business or other assets that are not as liquid as cash holdings.
When Might This Strategy Not Be a Good Fit?
- If you have a taxable estate that is below the Federal Tax Exemption threshold.
- You want to see your beneficiaries enjoy their gifts while you are living.
- You want flexibility and control over your assets.
- Your health situation doesn’t make life insurance a viable option.
There is the added expense of having the trust drafted, but the benefits to holding the policy inside of the trust make it a worthwhile expense. Not only can you direct how the eventual death benefit will be paid out, but you can also shield beneficiaries if they have issues that arise from divorce or creditors. You can also have an independent trustee like a bank professionally manage the policy and eventual death benefit.
Conclusion
An irrevocable life insurance trust can be a valuable planning tool if used in the right situation. It can allow you to leverage annual gifts and keep a large asset outside of your estate that you can pass along to beneficiaries tax-free. You should note that this is a simplified explanation of how an ILIT works. It is best to consult with your tax adviser to see if this is a good fit for your situation. Would you like more information on how an ILIT works? Please feel free to give us a call at (888) 687-9444 or email us at info@archstoneagency.com if you have any questions.
Archstone Insurance Services, LLC is an independent agency that shops over 40 of the top life insurance carriers to provide huge savings on life insurance coverage for our clients. We are happy to answer any questions you might have about any of the insurance products we offer, your planning needs or your existing coverage. Feel free to call us directly at (888) 687-9444 or email us at info@archstoneagency.com. You can also visit our website at www.archstoneinsurance.com.
