An ILIT is short for Irrevocable Life Insurance Trust. This kind of trust owns a life insurance policy and is commonly used to bypass estate taxes. These days, the current estate tax rate is $11.2 million a person, which means few clients need to be concerned about estate tax; however, ILITs have other purposes too.
To fund an ILIT, you purchase a life insurance policy and gift the policy to the trust. Then the trust is the owner and continues to pay for the premiums. Each year, you gift the amount of the premiums, or the maximum tax-free amount (currently $15,000 a person) to the trust. The Trustee (a child, friend, attorney, or financial institution) pays for the insurance premiums from this cash gift. Because you have contributed the annual tax-free amount to pay for the premiums, there are no taxes on the money used to pay for the policy; however, to take advantage of this annual amount, you must make the beneficiaries aware of your cash gift, and they must renounce their interest in the gift. Upon your death, the insurance amount passes to the beneficiaries under the terms of the trust, tax-free.
For example: Either you purchase a one million-dollar ($1,000,000) life insurance policy and gift it to your ILIT, or you gift cash to the trust and the trust purchases a life insurance policy. Your ILIT names your eldest child as the trustee, and your three children are equal beneficiaries of the trust at your death. Each year you gift fifteen thousand dollars ($15,000) to the trust and get each of your children to sign a letter (known as a “crummy letter”) that says they understand they COULD take the fifteen thousand dollars ($15,000), but are choosing not to and leaving it in the ILIT. The Trustee then takes the fifteen thousand dollars and pays the monthly premiums. Upon your death, the one million dollars is divided equally among your three children and passes to them directly without probate or other process and is tax free.
Aside from taxes, an ILIT provides an efficient way of getting money to beneficiaries without probate proceedings. An ILIT also provides for the ability for the funds to continued to be managed, rather than given outright. For beneficiaries who are disabled, incompetent, or simply poor money managers, leaving large amounts of funds outright may not be the best course of action. An ILIT allows you to create lifetime trusts, special needs trusts, or trusts for under-age beneficiaries, all while allowing you to choose who controls and manages those funds, and under what terms that person may make such distributions.
Although the “irrevocable” part of an ILIT may be daunting for some people, don’t let it fool you. The trust requires annual gifts to continue to pay the premiums. If you stop giving money to the trustee and stop paying the premiums, the policy lapses and the ILIT is effectively non-existent. Additionally, you choose who the trustee of your ILIT is. While you, directly, have no power to dissolve the trust or pull money from the premiums, your ILIT can add terms that allow your trustee to take such actions.
While an ILIT is not for every family, there are many ways it can be used as an advanced estate planning technique. If you feel that an ILIT would benefit you, please make an appointment so we can help you make the best plan for your future.
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