An irrevocable life insurance trust (ILIT) is a valuable way to protect your estate and create security for your permanent life insurance. 

An ILIT is uniquely designed for people and families looking to avoid estate taxes on the death benefit of their life insurance policy. This type of policy, compared to traditional whole life or permanent life policies, is owned by the family trust rather than a person. If you’re estate planning, there are some key things you need to know about an ILIT that will help you decide if one works for your family. 

Choosing the right company for your ILIT is easy when you use Insurify to compare rates and policies. You’ll have the information you need to make the best decision for you and your loved ones. 

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What is an irrevocable life insurance trust? 

The concept of an irrevocable life insurance trust is quite simple. An ILIT is a trust that has ownership of one or more life insurance policies. This trust can own policies that insure anyone in your family. The life insurance policies are usually purchased separately from the irrevocable trust. 

If you already have an existing policy with you as the owner, it is never too late to transfer the ownership. But if you die in the first three years of the transfer, the IRS will consider it invalid, and your life insurance policies get combined with your taxable income.  

The most effective way to get an ILIT if you’re purchasing both the trust and life insurance policy for the first time is to consult with an attorney to create your legal trust documents. You’ll follow the standard process when purchasing your life insurance policy.

Insurify can help you get started. Once you’ve chosen an insurer, you’ll need to provide your trust documents in order to name it as the owner. 

The ILIT is made up of three main elements: 

  • The grantor: the person who created the trust, who is typically the insured party, and supplies the initial investments into the trust
  • The trustee: the person you choose to manage the trust and has the power to make limited changes to the trust
  • The beneficiary: the person who will receive the assets or payout of the trust or life insurance policy

The trustee has the right to make changes and add or remove beneficiaries on your policy, with your written consent or as stated in your trust document. Many policyholders have the trust as the beneficiary, and that typically never changes. 

Naming your spouse or adult children as a trustee is acceptable, but it’s better to name a financial advisor with experience to manage the funds. As the grantor, you still have control over the policy by outlining specific details and instructions in your trust document. You and your family will not receive the same estate tax exemptions on your trust-owned policy if you designate yourself as the trustee.  

Setting up an ILIT as the beneficiary of your life insurance is a simple process. Many companies require a form, or you can just call customer service and make the change quickly. However, insurers do place some restrictions on how frequently beneficiaries can be changed to protect your policy from fraud.

The creator of the family trust, the grantor, has the power to name the trustee as the beneficiary. Trustees can be an individual or an institution. There are a few benefits to naming the trustee as the beneficiary. For instance, if your beneficiary is a member of your family, the court may take control of the money if that person is unavailable or is mentally or physically unable to make decisions at the time of your passing. 

The same as changing or adding beneficiaries, transferring ownership is simple and usually requires a form. You can check with your life insurance company to see if this change can be made over the phone. Transferring ownership of your policy to your trust has no impact on your life insurance premiums

Can changes be made to an ILIT?

As an irrevocable trust, changes generally cannot be made, but there are exceptions: changes in trustee and changes approved by your “trust protector.” A trust protector is a third-party service that examines trust documents and determines if a change can be made.  

Irrevocable Insurance Trusts and Taxes 

A key benefit of an ILIT is the ability to reduce estate taxation. This protects your policy death benefit and cash value that grows over time. This may lead you to ask, “How exactly does an ILIT reduce estate taxes?” 

An ILIT reduces estate taxes because it allows you and your family to avoid incidents of ownership by allowing your trust to own your policy. Since ownership is in the name of the trust, the cash benefits of your policy will not be included in your estate. You don’t want to make the mistake of choosing another member of your family as the owner of your policy, as the risk of estate taxes will then be transferred to them. 

If your family has to pay estate taxes after you transfer ownership to the trust, you can further reduce the tax costs by using your trust to purchase more policies. This is a good idea because as the owner, the life insurance proceeds will not be included in income tax, funds are available sooner after the insured passes, and your family avoids probate court.

Universal life insurance policies are ideal for this particular situation. Universal life policies are used as an investment tool and have more financial flexibility than other types of life insurance policies. Because you can “dump” lump sums of money into these policies, having an ILIT own the policy will save those investments from a large tax bill

In 2020, the federal estate tax exemption applies to estates over $11.58 million. While this tax cut will help you on the federal level, each state has its own exemptions. Many states begin taxing estates worth $1 million or less. Reaching $1 million in assets is more common than many people consider. With taxes ranging from 18 to 40 percent, placing part or all of your family’s wealth into a trust will make a huge difference financially. 

For example, a grantor with a $500,000 life insurance policy and a home worth $500,000 would be subject to a tax consequence. In the event of their death, the beneficiaries would be responsible for paying those taxes. Transferring the proceeds from your life insurance policy into an ILIT will protect your family from high tax percentages. It’s vital to know how your state operates to ensure you receive any estate tax exemption you qualify for. 

If your life insurance policy is owned by your trust, the death benefit will not be included in any state or federal gift tax

The tax rate is also reduced when your trust buys a new policy. Your selected trustee will buy the policy on behalf of the trust, and you will provide the funds to purchase the new policy. This cash transfer between yourself and the trustee is subject to a gift tax. It helps to know that you can make tax-free gifts of up to $13,000 per year or $26,000 if you make a transaction with your spouse. 

Crummey Power 

Crummey power is a technique that helps people receive or give a gift without paying the usual gift tax. Crummey power is primarily used for putting funds into your trust as a “gift.” This makes you eligible for the annual federal gift tax exclusion. This exclusion applies to deposits up to $15,000.  

An irrevocable life insurance trust is one of the best financial products available. It is essential for estate tax purposes. You’ll be adding generations of protection to your family. There is no limit on when you can purchase an ILIT. You can buy one at any time and ensure you haven’t left out any key details. Don’t be afraid to weigh different options and have discussions with your family about what’s best for everyone’s financial future. 

How to Buy the Best Life Insurance Policy

Choosing the best policy is as important as the life insurance company you buy it from. Compare quotes and premium costs on Insurify to help you decide which policy and company fit your financial needs. Comparisons are fast, free, and easy. 

No matter your budget or coverage needs, you can take a few minutes to view rates and plans that will support your family now and in the future. 

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Updated November 25, 2020

Brooke Taylor is a freelance writer with a passion for storytelling and educating others. She has experience in life insurance and has been active in helping consumers make more informed decisions. When she's not writing, Brooke is reading a good book or being a mom of four. To learn more about Brooke you can visit her website www.brookeuniverse.com.