What is a life insurance trust?
UPDATED: December 16, 2019
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An irrevocable life insurance trust, or ILIT, is a trust set up by a couple with a third party trustee and is meant for the purchase and distribution of life insurance. The ILIT can be used as a shelter for both term and whole life insurance policies and is useful for both old and young couples as a means of removing life insurance from their estate.
Irrevocable LIfe Insurance Trust Structure
The person who is being insured creates the ILIT and deposits funds into the trust for the use by an independent trustee. The trustee utilizes the trust’s funds to purchase a life insurance policy but names the trustee as the owner and beneficiary of the life insurance trust. In order to avoid the estate tax consequences of having the funds placed into the trustor’s estate, the trust must be irrevocable. Also, the trustor cannot be a named beneficiary on the life insurance trust or the trust will be considered a taxable future gift. Finally, the other spouse can be named as a beneficiary so long as they are also not named trustor. Ideally, two of these trusts should be set up if the couple is younger and trying to replace income.
After the death of the first spouse, the trustor then uses the life insurance money to either purchase assets from the estate of the deceased spouse, to keep them safe in the ILIT, and can lend some of the funds to the living spouse to pay any estate taxes. The remaining funds of the trust can be used to support the living spouse, children or even grandchildren.
Continual Life Insurance Payments
There are two possible scenarios for taking care of the life insurance premiums. First, the trustor can annually deposit the payment amount into the trust. This ensures that each year the policy is paid on time. Alternatively, enough assets can be deposited into the trust so that the interest from those assets pays for the life insurance. This second approach is typically more beneficial for older couples who have larger estates that need assets removed. Keep in mind that the life insurance trust is irrevocable, so once funds are placed into the trust they cannot be taken out.
Irrevocable Life Insurance Trusts and Gift Taxes
On their face, an ILIT does not avoid gift taxes because it does not directly skip generations. However, the trust can be drafted using a Crummey provision that would shelter the trust from present gift taxes. A Crummey provision authorizes the couple’s grandchildren the chance to withdraw any amount, lesser the corpus, of the trust at the same time annually. In order for this provision to remain in tact, the child must withdraw a small amount each year. Many parents will authorize their children to withdraw $1 annually from the trust in order to meet the requirement and avoid taxes for another year.
If a life insurance trust seems like a useful addition to your estate planning portfolio, contact an estate planning attorney for a consultation. Drafting a lawful and beneficial trust can be complex, your attorney can ensure your meet all the necessary requirements.