Irrevocable Life Insurance Trusts
An In-Depth Overview Of An Irrevocable Life Insurance Trust
Irrevocable life insurance trusts (ILIT) is a trust that cannot be amended and/or revoked, and is both the beneficiary and owner of a single or multiple life insurance policies. In an irrevocable trust, a life insurance policy is set as the asset, which allows this asset to be exempted away from the taxable estate of the grantor of the policy.
Usually, the life insurance trust is used so that cash proceeds can be set aside in order to use them to pay estate taxes. This becomes possible since the life insurance policy is exempted from the taxable estate of the insured’s decedent. After the placement of the life insurance policy in the trust, the policy is no longer owned by the insured person. This means that after the death of the insured person, the Trustee manages the life insurance policy on behalf of the policy beneficiaries.
Once the insured person dies, the insurance proceeds are invested by the Trustee and the trust is administered for a single or multiple beneficiaries. If insurance is owned by the trust on behalf of a married person, the beneficiaries of the insurance trust are usually the non-insured spouse and children. The trust may also be the owner of survivorship or “second to die” insurance, which is only paid in case of the death of both the insured and non-insured spouse. In this case, the children are the beneficiaries of irrevocable life insurance trusts.
In the United States, the only way of preventing the insurance proceeds to fall under federal estate taxation is through proper ownership of life insurance. If the insured person owns the policy, estate tax is applicable on the proceeds. In this case it is assumed that estate tax is applicable because the estate and the life insurance have a large enough aggregate value. Estate taxation can be avoided by name a spouse, child or other beneficiary as the insurance policy’s owner. However, doing so has its drawbacks, and that is why an irrevocable trust is usually the solution.
If possible, the owner and the original applicant of the insurance should be the Trustee. An existing policy can be transferred by the insured to irrevocable life insurance trusts. However, the Internal Revenue Service will only recognize the transfer if the insured does not die within a period of at least three years after the date of the transfer. In case of the death of the insured within this three-year period, the Internal Revenue Service will ignore the transfer and include the proceeds in the taxable estate of the insured.
Insurance trusts may be both funded and non-funded. In a funded trust, both the income producing assets and a single, or multiple, insurance contracts are owned by the trust. The trust uses the income from the assets to pay all or some of the premiums. By custom, the insurance trust’s trustee has the authority to either buy assets from estate of the insured or loan insurance proceeds to the insured’s estate.
The bottom line is that since they are irrevocable life insurance trusts, only beneficiaries can make changes since all control is granted to them by the owner. If the taxable estate has a value less than the maximum exclusion figure, setting up an irrevocable trust is generally not necessary. In this case, the life insurance is included in the taxable estate of the descendant.
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