Did you know that if you own a life insurance policy in your own name, its proceeds will be included in your estate, and there’s a possibility it will be taxed up to 40%?
However, if you use an irrevocable life insurance trust, or ILIT, to hold title to your life insurance policy, you may avoid having the death benefit included as an asset in your estate. This can save your heirs hundreds of thousands (maybe even millions!) of dollars in taxes.
It’s a complicated process, but creating an ILIT might be worth it.
Motley Fool’s recent article, “What's an Irrevocable Life Insurance Trust and Why Do I Need One?” explains just what an irrevocable life insurance trust looks like.
An ILIT is a trust with the primary purpose of holding a life insurance policy and the cash needed to pay premiums on that policy. You would need to fund the trust with money to pay initial premiums when you set it up. The trust then buys the life insurance policy, naming you as the insured.
The ILIT has to be created so that it avoids giving you “incidents of ownership.” These are the rights to borrow against the policy, to change beneficiaries or to change how proceeds are distributed from the trust. If you retain any of these rights, then the death benefit will be included in your estate and subject to estate taxes.
The ILIT usually pays the ongoing premiums by receiving future gifts from you as the person who set up the trust. After your death, the other provisions of the trust will apply.
A named trustee will manage the assets and make sure the assets are invested to meet the future needs of your beneficiaries. When all the protective terms of the ILIT are satisfied, the trust can terminate, and final distributions are made to its recipients.
The major benefit of the ILIT is that the proceeds of the life insurance policy aren’t taxed. The estate tax on a $1 million policy can be as much as $400,000—so the savings from an irrevocable life insurance trusts may justify the expense of an attorney creating it for you.
There can be some issues with ILITs—the most common of which is when the cost of continuing the life insurance policy becomes prohibitively high. That can make the ongoing funding of the trust burdensome. The ILIT trustee might have to borrow against the policy value or surrender the policy entirely. It can mean that the beneficiaries are at odds with the trustee.
Despite this, potentially saving a large amount of money in estate taxes makes ILITs worth the effort. Work with an experienced estate planning attorney so your ILIT meets your needs and those of your family.
Reference: Motley Fool (August 24, 2016) “What's an Irrevocable Life Insurance Trust and Why Do I Need One?”