Irrevocable Life Insurance Trust

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

What is an Irrevocable Life Insurance Trust?

An Irrevocable Life Insurance Trust, often abbreviated as ILIT, is a type of trust specifically designed to hold and manage a life insurance policy. The central element here is the term “irrevocable,” which implies that once the trust is created and the insurance policy is transferred into it, the terms of the trust cannot be altered. The policy cannot be removed or changed without the beneficiaries’ consent.

An ILIT is a legal entity that removes your life insurance policy from your taxable estate. This can provide a means to pass on wealth to your loved ones without burdening them with significant estate taxes.

Irrevocable Life Insurance Trust

How does an Irrevocable Life Insurance Trust work?

When it comes to the operation of an ILIT, the process is relatively straightforward. As the policy owner (the grantor), you would establish the trust, name a trustee, and designate the policy’s beneficiaries. The trustee then manages the trust according to the terms you set.

Once the life insurance policy is transferred into the trust, it technically belongs to the trust and is controlled by the trustee. When the grantor passes away, the policy payout (death benefit) goes into the trust and is distributed to the beneficiaries according to the trust’s terms.

This approach means that the death benefit isn’t considered part of your estate, so it generally won’t be subject to estate taxes. This setup makes the ILIT a powerful tool in estate planning.

Who needs an Irrevocable Life Insurance Trust?

An ILIT can be a valuable tool for individuals with a substantial estate and a sizeable life insurance policy. If the combined value of your life insurance policy and other assets exceeds the estate tax exemption limit, an ILIT can help reduce potential estate tax liabilities.

Let’s look at an example. Suppose John has an estate worth $15 million and a life insurance policy worth $5 million. If the estate tax exemption limit is $11.7 million, then without an ILIT, John’s estate could be subject to estate taxes of $8.3 million ($20 million – $11.7 million). With an ILIT, the life insurance death benefit would be removed from the estate, potentially reducing the taxable amount by $5 million.

Why do people need an Irrevocable Life Insurance Trust?

There are several reasons why someone might choose to set up an ILIT. Besides reducing potential estate tax liabilities, an ILIT can control insurance funds even after death. This control can be helpful if the beneficiaries are minors or the grantor has concerns about their ability to manage large sums of money.

While ILITs can have numerous benefits, they are not without drawbacks. The life insurance trust disadvantages primarily revolve around their irrevocability. Once established, an ILIT can be difficult to amend or dissolve, limiting the grantor’s flexibility.

Is an ILIT a Grantor Trust?

Yes, an ILIT is a type of grantor trust. This means that while the grantor is alive, the IRS considers the trust assets still owned by the grantor for income tax purposes. However, upon the grantor’s death, the trust assets, including the life insurance death benefit, are removed from the grantor’s estate for estate tax purposes.

Irreversible Life Insurance Trusts

Can You Change the Beneficiary of an Irrevocable Life Insurance Trust?

Changing the life insurance trust beneficiary can be pretty complex. Since the trust is irrevocable, altering the terms—including changing beneficiaries—is typically impossible without the consent of all current beneficiaries and often requires court approval.

Who is the Owner of an Irrevocable Life Insurance Trust?

In the case of an ILIT, the trust itself is the owner of the life insurance policy. This ownership setup excludes the death benefit from the grantor’s estate. However, the trust’s grantor maintains control over the terms of the trust during their lifetime, with the trustee overseeing the operation of the trust according to those terms.

Next Steps

An Irrevocable Life Insurance Trust can be a powerful tool for estate planning. It offers potential tax advantages, ensures the appropriate management of life insurance benefits, and provides control over how and when beneficiaries receive their inheritance. However, the irreversible nature of these trusts requires careful consideration and planning. Consulting with a knowledgeable estate planning attorney or financial advisor is crucial to ensure an ILIT fits your circumstances correctly.

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Frequently Asked Questions

Can a Beneficiary Be the Trustee of an ILIT?

Legally, it is allowed for the beneficiary of an ILIT to also act as the Trustee without any issues.

Do irrevocable life insurance trusts file tax returns?

The ILIT must file state and federal income tax returns yearly, even though it typically doesn’t have taxable income during your lifetime. Additionally, it has its federal tax identification number.

What happens to an irrevocable trust when the person dies?

When the creator of an irrevocable trust passes away, the trust remains in place until the assets are all distributed by the successor trustee. The successor trustee is also tasked with overseeing the assets designated for a minor and placing them into the child’s sub-trust.

Can you borrow against an irrevocable life insurance trust?

As an individual, you can borrow against the cash value accumulation of your policy. However, once you transfer or purchase a policy for your Irrevocable Life Insurance Trust (ILIT), borrowing against it is no longer an option. Additionally, once you pay the premiums to the trust, you will no longer have access to those funds since you are not the policy owner.

Can you remove a beneficiary from an irrevocable trust?

Beneficiaries cannot be changed in an irrevocable trust as its terms are usually fixed.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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