Irrevocable Life Insurance Trusts
Irrevocable Life Insurance Trusts
Questions
• What is an irrevocable life insurance trust?
• What type of life insurance policy should be recommended?
• Why is it important that the trust own the insurance?
• How does an irrevocable life insurance trust work?
• Can an existing life insurance policy be transferred to an irrevocable life insurance trust?
• Who should be the trustee of an irrevocable life insurance trust?
• How do I get started?
• How can the Edward Jones Trust Company help?
Use of Life Insurance
Life insurance can be an important component of an estate plan:
• Provides funds to protect loved ones if an individual dies prematurely
• Protects a family business from being liquidated if a family member dies without a succession plan in place
• Helps minimize the amount of an individuals estate lost to estate taxes
• Provides liquidity for an estate to pay applicable estate taxes
Although most individuals are aware of the primary benefits of life insurance, there are other aspects that may be less widely known. Do clients know that how they register life insurance may be just as important as how much or what kind is purchased? For some individuals, creating a life insurance trust ensures that maximum income and estate tax benefits are achieved.
What is an Irrevocable Life Insurance Trust?
Generally, an irrevocable life insurance trust (ILIT) is established to purchase and hold a life insurance policy. Typically, money is gifted to a trustee who is authorized to use those dollars to purchase a life insurance policy on an individual’s life. If structured properly, the premium paid into the trust qualifies for the annual per person gift-tax exclusion. By taking advantage of the annual gift-tax exclusion, the client avoids losing any of their unified credit. Significant estate tax benefits can be gained because the insurance is owned by the trust and will not be included in the clients taxable estate.
What Type of Life Insurance Policy Should be Recommended?
Since estate planning and wealth transfer are generally lifelong needs, permanent life insurance is usually considered.
In the case of a husband and wife, a second-to-die or survivorship policy is often considered. This is because estate taxes are generally not due until the second death, and the insurance is more affordable when two lives are considered.
Why is it Important That the Trust Own the Insurance?
At a person’s death, when estate tax liability is determined, everything that person owns will be included in their taxable estate. If they own a life insurance policy, the amount of the death benefit paid to their beneficiaries will be included in the total of their taxable estate. This can significantly increase the value of their estate, which may also increase the estate taxes due.
An alternative solution is to own the life insurance outside of the person’s estate. If the life insurance is owned by someone else, it is not included in the value of their taxable estate for estate tax purposes. An irrevocable life insurance trust provides an ownership alternative. If structured properly, the irrevocable life insurance trust keeps insurance dollars separate from their gross estate, maximizing the amount received by heirs.
How does an ILIT Work?
Once the trust is created, an individual gifts sufficient funds to the trust to cover the annual life insurance premium. To qualify this gift for the annual per donee gift exclusion, the trust beneficiaries must have the absolute right to withdraw the funds that have been gifted to the trust (usually for a limited amount of time). The beneficiaries, however, will normally decline this right to withdraw and will leave money in the trust. The trustee is then authorized to use those dollars to pay premiums on an insurance policy on the grantor’s life.
At the insured’s death, the proceeds from the life insurance policy are paid to the trust. The trust document will include provisions for use of the proceeds. Provisions may include an option to loan money to the estate, to purchase assets from the estate or to pay a lump sum (or possibly an income stream) to the beneficiaries.
It’s important to remember that these types of trusts are irrevocable, which means they cannot be changed. The trustee can cancel the life insurance policy if the donor decides to discontinue gifting money to the trust to pay the premiums, but the accumulated cash value cannot be returned to the insured. For this reason, it is important to carefully consider the advantages and disadvantages of this type of trust prior to utilizing it in one’s estate plan.
Can an Existing Life Insurance Policy be Transferred to an ILIT?
Yes, an insured person can gift an existing life insurance policy to the trustee to be held in the trust. Gifting a current policy can have negative gift and/or estate tax implications, so it is important to talk with a legal advisor about the ramifications of such a transfer.
Who Should be the Trustee of an ILIT?
The selection of a trustee is another important consideration when setting up this type of trust. The trustee is responsible for setting up the trust account, receiving the gifts from the grantor, notifying trust beneficiaries of these present gifts, and paying the life insurance premiums. This is not a job that should be taken lightly, as the documentation requirements are vital to ensure the trust achieves the desired gift and/or estate tax benefits.
It is important that a client considers all of these responsibilities when choosing a trustee.
You should not serve as trustee of your own irrevocable life insurance trust. If you act as your own trustee, the Internal Revenue Service may determine that the retention of certain powers will cause inclusion of the proceeds in your taxable estate. A spouse may be selected as a trustee, but it’s equally important to have proper provisions in the trust to avoid inclusion of the proceeds in his or her taxable estate at death.
Normally, an individual other than a spouse is selected to serve as trustee. The client’s attorney can help determine what options are available and which best fit your client’s particular needs. A corporate trustee can also be named as trustee or successor trustee. The successor trustee serves as trustee in the event the primary trustee is unable to serve.
How do I Get Started?
If you think an irrevocable life insurance trust might help achieve your client’s estate planning objectives, assemble a team of capable professionals to assist you. An estate planning attorney can help your client review their current plan and determine whether this type of trust is appropriate for their needs. A CPA or tax professional will assist with tax planning. Since you know your client’s personal situation, understand their long-term financial goals and can provide guidance in selecting a life insurance policy, you can be a tremendous asset to your client. Edward Jones Trust Company can also be an important part of your client’s estate planning team by serving as trustee.
The Benefits of an Irrevocable Life Insurance Trust
With an irrevocable life insurance trust, the trust is the owner of the insurance policy, which keeps the proceeds of the life insurance out of your taxable estate. In addition, as you make gifts to fund the insurance premiums, you reduce your taxable estate. After your death, the trust's assets (the insurance proceeds) are available to your beneficiaries income-tax-free.
Help Pay Estate Taxes With an Irrevocable Life Insurance Trust
Irrevocable life insurance trusts also can be an important source of cash to help pay the estate taxes on your estate. The beneficiaries of the irrevocable life insurance trust can use the proceeds from the life insurance policy to offset some of the taxes that may be owed on your estate. This can help keep the assets that are part of your taxable estate intact for your beneficiaries. This strategy can be especially useful if a large portion of your estate consists of real estate or a closely held business and you want to be sure that your family will not be forced to sell those assets in order to pay estate taxes.