If you are starting your estate planning process, an ILIT (irrevocable life insurance trust) will provide peace of mind. If you have young beneficiaries or sizeable estate, the trust will be able to provide control over a life insurance policy.
The irrevocable aspect of the trust ensures that the creator or the grantor will not be able to change it after it is setup. ILIT is primarily used as an estate planning and financial planning tool to protect assets subject to high estate taxes.
What Do You Need to Know About an Irrevocable Life Insurance Trust?
A revocable trust enables the grantor to make changes to the trust. You will also be able to end the trust if you want to. An irrevocable trust will not allow any changes to be made after it is setup. Only beneficiaries will be able to change the trust.
Revocable trusts are more common as they offer flexibility to the trust creator. An irrevocable life insurance trust is a good idea if you want to save taxes.
A grantor will set up the irrevocable trust and fund it. Transfers and gifts are then made to the trust. Transfers and gifts are permanent. Changes not allowed to the trust and its funds after set up.
The trustee manages the trust. Distributions made to beneficiaries are also managed by the trustee. The trustee who manages the trust is different from the grantor.
Benefits of an Irrevocable Life Insurance Trust
- Lower Estate Tax
Death benefits will not form part of the gross estate when you opt for an irrevocable trust. This means the benefits are not subject to federal and state estate tax.
The trust will also be able to cover debts and estate tax costs when the estate makes the purchases. The grantor will not be able to make the purchases as the estate is now part of the trust.
It is important to know that even though the estate is exempt from estate taxes, the beneficiary’s estate will be subject to such taxes. The tax burden shifts to the beneficiaries.
When ILIT is drafted properly, it helps provide liquidity. This will help pay estate taxes and other expenses and debts. It is done through a loan or purchasing assets from the estate of the grantor.
Lifetime gifts will help reduce the taxable estate. This is done by transferring assets into an irrevocable life insurance trust.
- Protect Assets from Creditors
An irrevocable trust will be able to protect you from certain legal proceedings. Protect assets from creditors by setting up the trust.
The creditors, however, will be able to attach distributions made from ILIT.
- Avoid Gift Taxes
The contributions by the grantor to the beneficiaries are considered gifts. If you want to avoid gift taxes, it is important that the trustee notifies the beneficiaries about the right to withdraw.
The letter notifies the beneficiaries right to withdraw for a 30-day period.
After the 30-day period, the trustee will be able to pay the life insurance premium using the contributions.
The transfer for the annual gift tax can be excluded as the letter makes the gift a present instead of future interest. This helps avoid the need to file a gift tax return.
- Leaving Assets to Minors and Ensuring Responsibility
Minors are not equipped to handle large amounts of money and assets. An irrevocable trust will allow you to put restrictions in place to protect the assets.
Restrictions such as the beneficiaries reaching a certain age to gain access to the assets can be put in place. The creation of a trust will help ensure responsible behavior from adults or minors with reckless spending habits.
The trust is supervised by an appointed trustee. The assets will be distributed as per the grantor’s wish. This provides asset protection for the beneficiaries.
As ILITs are not owned by the beneficiaries, the assets are protected even if there is future litigation involving the beneficiaries.
Linking the assets to the beneficiary is difficult. This prevents creditors from accessing the assets.
- Government Benefits
Trust beneficiaries receiving government aid (Medicaid or Social Security Disability Income) are protected with the proceeds received from a life insurance policy purchased by an ILIT.
The trustee will be able to control how trust distributions are used. This is done carefully so that it doesn’t obstruct the beneficiary’s entitlement to get government aid.
- Legacy Planning
The generation-skipping transfer tax stipulates a 40% tax on transfers and gifts in trust. The tax is also applicable when the gift or transfer is made to unrelated persons more than 37.5 years younger to the donor.
Related persons who are more than at least a generation young than the donor will also be covered as per the tax provisions. Donors gifting assets to grandchildren instead of children is a common example.
ILIT will help the grantor leverage the generation skipping transfer tax exemption. Gifts to the trust are used to fund and buy the insurance policy.