An irrevocable life insurance trust, or ILIT, is a financial tool you use to manage life insurance policies and allocate benefits when you pass away.
Above all, once set, you cannot alter or terminate an irrevocable life insurance trust.
An irrevocable life insurance trust involves three legal parties.
- The grantor: The grantor begins and finances the trust. They also choose the trustee to manage the trust.
- The trustee: The trustee pays the life insurance premiums. collects the death benefit when the grantor dies and disburses the payout to the beneficiaries.
- The beneficiaries: The grantor can choose one or more beneficiaries to receive the irrevocable life insurance trust benefits.
How Life Insurance Irrevocable Trust Works
Chiefly, the purpose of an ILIT is as a trust to hold life insurance. It exists separately from the grantor’s estate. So it is not included in the estate’s value. Hence, the trust is the payor of the life insurance policy or policies in it rather than the policy owner.
Since the ILIT buys and owns the life insurance policy, the guarantor usually pays the trust and the trustee uses the funds to pay the life insurance premiums. Eventually, when the guarantor dies, the trustee then collects the life insurance payout and distributes it to the beneficiaries.
Irrevocable Life Insurance Trust Benefits
- Tax advantages. ILITs give some tax advantages. For example, high-net worth individuals can use an ILIT to reduce the burden of estate taxes (which are often hefty) on their heirs. To this end, the provide cash to pay the estate taxes so beneficiaries can still hold the estate’s assets.
- Legacy planning. Additionally, it lets you control how your beneficiaries use the death benefit. This is in contrast to merely naming them as life insurance beneficiaries, in that case they could spend the death benefit however they like.
Irrevocable Life Insurance Trust Drawbacks
As we have seen, ILITs have advantages regarding specific tax and legacy planning goals.
- ILITs are unchangeable. You cannot amend the provisions of the ILIT once you have created it.
- ILITs may be taxable. If you die within three years of creating an ILIT, then the trust’s life insurance policy may be included in your estate. In that case, it could be subject to estate taxes along with your other assets.
- You do not own the trust’s policy. So you cannot amend the policy. Rather your trustee manages the policy and the payouts within the legal provisions of the trust.
Establishing an Irrevocable Life Insurance Trust
An ILIT is a complicated legal entity, so they require expertise to set up. Therefore, you should work with both an experienced lawyer and a financial advisor to properly set up the trust.
Additionally, the main difference between purchasing a life insurance policy yourself and doing so under a trust is that the trust is listed as the owner rather than the insured.
Furthermore, while an ILIT has advantages, experts warn that it is important to fully understand the estate’s assets and the trust’s objective. To this end, experts recommend creating a personal board of directors that includes a financial planner, insurance advisor, trust and estate attorney to collaborate in managing the trust.
Above all, it is important to remember it is not usually possible to dissolve an ILIT. Although a court may be able to dissolve it under specific conditions.