• Peter C. Ciravolo

Irrevocable Life Insurance Trusts (ILIT) 101


****BC Brokerage, LLC is an insurance brokerage firm that specializes in life insurance, disability income, long term care, and annuities. We are not tax professionals. We are insurance brokers, producers, and distributors of multiple insurance products through multiple insurance carriers. Each and every financial plan is different. Please consult with your Financial Advisor, Certified Public Accountant (CPA), and Estate Planning Attorney to see if an Irrevocable Life Insurance Trust (ILIT) is right for you and your financial plan!****

Image credit due to Michael Kitces - www.kitces.com


What Is an Irrevocable Life Insurance Trust (ILIT)?


An ILIT is created to own and control a life insurance policy on an insured individual, as well as to manage and distribute the proceeds that are paid out upon the insured’s death.

An ILIT has few parties:

  • The Grantor - typically creates and funds the ILIT. Gifts and transfers made to the ILIT are permanent, and the grantor is giving up control to the trustee.

  • Trustee(s) - manages the ILIT (Financial Advisor, Appointed Family Member, Lawyer)

  • Beneficiary (ies) - receive distributions from ILIT

The Grantor must avoid any ownership of the life insurance policy. Any premiums paid towards the life insurance policy should come from a checking account owned by the ILIT.

If the Grantor transfers any existing life insurance policy to the ILIT, there is a three year lookback period in which the death benefit could be included in the Grantor's estate. There can also be gifting problems if the policy being transferred has a large accumulated cash value. It is crucial to refer to inforce illustrations and cost basis.

Once established and funded, an ILIT can serve many purposes including the following:

Minimizing Estate Taxes

If the insured is the owner of the policy, then the tax-free death benefit of a life insurance policy will be included in your gross estate. However, when life insurance is owned by an ILIT, the proceeds from the death benefit are not part of the insured's gross estate and thus not subject to state and federal estate taxation. This creates the advantage of using an ILIT in estate plans.

When properly drafted an ILIT can also provide liquidity to help pay estate taxes, as well as other debts and expenses. Assets can be purchased from the Grantor’s estate or through a loan.

Meeting Gift Tax Maximum Guidelines

In 2021, an individual can give $15,000 a year to as many individuals as they’d like. A married couple can give the same individual a combined $30,000 annually, gift-tax free. There is no limit to the total number of gifts a couple may make either. You can also give someone more than $15,000 a year with the excess being applied toward your lifetime estate tax exemption of $11,700,000 for 2021.

A properly drafted ILIT avoids gift tax consequences since contributions by the Grantor are considered gifts to the beneficiaries. To avoid gift taxes it is crucial that the trustee, using a Crummey letter (an annual written notice to the beneficiary describing the right to withdraw the amount and indicating the time limit for that withdrawal), notify the beneficiaries of the trust of their right to withdraw a share of the contributions for a 30-day period. After 30 days, the trustee can then use the contributions to pay the insurance policy premium. The Crummey letter qualifies the transfer for the annual gift tax exclusion by making the gift a present rather than future interest, thus avoiding the need in most cases to file a gift tax return.

Distributions

The trustee also can have the discretion to provide distributions to beneficiaries when they attain certain milestones, such as graduating from college, buying a first home, or having a child. This can be a very useful way in second marriages to ensure how assets are distributed or if the grantor of the trust has children who are minors or need financial protection.

Legacy/Generation Planning

The generation-skipping transfer tax (GSTT) imposes a tax of 40% on both outright gifts and transfers in the trust to or for the benefit of unrelated persons who are more than 37.5 years younger than the donor or to related persons more than one generation younger than the donor. A common example of this is gifting to grandchildren instead of children.

An ILIT helps leverage the grantor of the trust’s generation-skipping transfer (GST) tax exemption by using gifts to the trust to buy and fund a life insurance policy. Since the proceeds from the death benefit are excluded from the grantor’s estate, multiple generations of the family—children, grandchildren, and great-grandchildren—may benefit from the trust's assets free of estate and GST tax.

Tax Considerations

Irrevocable trusts have a separate tax identification number and a very aggressive income tax schedule. However, the cash value accumulating in a life insurance policy is free from taxation as is the death benefit. So there are no tax issues with having a policy owned in an ILIT.

When properly designed, an ILIT can allow the trustee access to the accumulated cash value, by taking loans and/or distributions on a cost basis, even while the insured is alive. However, once a death benefit has been paid, if the proceeds remain in the trust, any investment income earned and not distributed to the beneficiaries could be taxed.

The Bottom Line

Irrevocable Life Insurance Trusts can be a powerful tool that should be considered in many wealth management plans to help ensure that your policy is used in the best possible way to benefit your family. And even with the individual federal estate and gift tax exemption at $11,700,000 in 2021, it is still possible to owe state estate taxes. Many states begin taxing your estate at $1 million or less.

Get in Touch

Contact BC Brokerage today for your ILIT needs analysis and quoting. We work for our clients and financial advisors, not an insurance carrier. We pride ourselves on educating our clients and matching their insurance to their financial plan. We keep our clients interests’ first! Click here to schedule a time with us.


Sources:


Kitces, Michael. “Unwinding An ‘Irrevocable’ Life Insurance Trust That’s No Longer Needed.” Nerd’s Eye View | Kitces.Com, 12 Dec. 2018, www.kitces.com/blog/unwinding-irrevocable-life-insurance-trust-rescue-modification-termination.




DISCLAIMER:

****BC Brokerage, LLC is an insurance brokerage firm that specializes in life insurance, disability income, long term care, and annuities. We are not tax professionals. We are insurance brokers, producers, and distributors of multiple insurance products through multiple insurance carriers. Each and every financial plan is different. Please consult with your Financial Advisor, Certified Public Accountant (CPA), and Estate Planning Attorney to see if an Irrevocable Life Insurance Trust (ILIT) is right for you and your financial plan!****

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