Life Insurance: Understanding a Key Part of Your Estate Plan, Part 3—Benefits of ILIT

Jun 21, 2016

By Ellen S. Jackson | Related Practice: Estate Planning & Administration

This is the last installment in a three-part series on life insurance. Part 1 provided an explanation of term and whole life insurance. Part 2 reviewed universal whole life, variable whole life and survivorship policies. This article reviews the benefits of having an irrevocable life insurance trust.

An irrevocable life insurance trust (“ILIT”) is created for the purpose of owning one or more life insurance policies, primarily to achieve estate tax savings by placing ownership of the policy in an entity other than the insured so that the death benefits are excluded from the insured’s estate.  In a typical situation, an insured person transfers a policy (or the money to purchase a policy) to an ILIT and then makes continuing gifts of cash to the trust so the trustee can pay the policy premiums.  After the insured’s death, the trustee manages the insurance proceeds for the benefit of the trust beneficiaries.

An ILIT must be irrevocable, meaning that the terms of the trust (such as the beneficiaries and when and for what purpose distributions can be made) aren’t generally subject to change.  Thus, before creating an ILIT, an insured must be comfortable with the loss of control over the policy.  The insured should also carefully consider selection of a trustee.  This is critical because the trustee is responsible for maintaining the policies owned by the ILIT, and for managing the money according to the trust’s terms after the insured’s death.  The insured may even give the trustee some measure of discretion over when, how and for what purposes the benefits can be made available to the beneficiaries.

If a person owns a policy insuring his or her life, then the full value of death benefits are included in his or her estate.  If the death benefits, along with the rest of the decedent’s estate, exceed the estate tax exemption amounts (currently, $2,079,000 per person for Washington decedents, and $5,450,000 per person federally), the death benefits may be subject to state and federal estate tax.  If, however, an entity separate from the insured owns the insurance, then the full amount of death benefits may pass to the beneficiaries free from both income and estate taxes.  An ILIT often serves as that separate entity.

Creating an ILIT involves a team of advisors: (1) an attorney to draft the trust document to achieve the client’s goals, assist the trustee with the beneficiary designation, and oversee the ongoing contributions to the trust; (2) a life insurance professional to communicate with the trustee to make sure premiums are paid year to year and assist with other policy maintenance issues; and (3) an accountant to monitor the trust and determine each year whether an income tax return must be filed by the trustee and whether a gift tax return must be filed by the insured.

If you are interested in learning more about life insurance, please contact a member of the Stokes Lawrence Estate Planning Group.