An Irrevocable Life Insurance Trust (ILIT) is a trust created to own and receive the proceeds from a life insurance policy. The person establishing the trust, called the grantor, gives up control over the policy after it is placed in the trust. An independent trustee manages the trust, handles premium payments and administers distributions according to the trust agreement. When structured properly, the policy’s death benefit is generally excluded from the insured person’s taxable estate. This can make ILIT estate planning useful for families concerned about estate taxes, liquidity or transferring wealth to beneficiaries in a controlled manner.
Life insurance proceeds can become part of a taxable estate when the insured person owns the policy or retains certain rights over it. An ILIT changes that ownership structure. The trust owns the policy and is generally named as its beneficiary. The trustee controls the policy rather than the insured person. At death, the insurance company pays the proceeds to the trust, which then manages or distributes the money according to its terms. This separation between the insured and the policy is central to estate tax life insurance planning because it can prevent the death benefit from increasing the value of the taxable estate.
Contributions to an ILIT are often used by the trustee to pay life insurance premiums. Normally, gifts to a trust may be considered future-interest gifts and therefore may not qualify for the annual gift tax exclusion. Crummey withdrawal rights address that issue. After a contribution is made, beneficiaries receive written notice that they have a limited period, commonly 30 to 60 days, to withdraw their share of the contribution. That immediate withdrawal right can cause the gift to qualify as a present-interest gift, allowing it to qualify for the annual gift tax exclusion. Proper notices and records are therefore an important part of ongoing ILIT administration and Trusts Accounting.
An ILIT normally begins with an estate planning attorney preparing an irrevocable trust agreement and identifying the trustee and beneficiaries. Ideally, the trust is established before the life insurance policy is purchased. The trustee then applies for the policy, with the trust serving as both owner and beneficiary. The grantor contributes money to the trust, the trustee provides required withdrawal notices to beneficiaries, and the trustee uses the funds to pay premiums. Transferring an existing policy is possible, but a three-year lookback rule may apply if the insured dies after transferring the policy. Careful coordination among legal, tax and insurance advisors is important.
An ILIT can be particularly useful when a family expects estate tax exposure or needs cash to prevent the forced sale of businesses, real estate or other illiquid assets after a death. It can also help with estate equalization, blended-family planning and controlled distributions to future generations. Other estate planning techniques, including Discounts for Lack of Control and Marketability, may address different parts of an overall wealth-transfer strategy. An ILIT may be less attractive when estate tax exposure is limited, premium costs would strain liquidity, or the grantor wants continued access to the policy because transferring ownership requires giving up substantial control.
The trustee should generally be someone other than the grantor who can administer the trust independently. Options may include a responsible family member, professional fiduciary, trust company or attorney. The trustee handles contributions, notices, premiums, records and eventual distributions.
Potentially. An ILIT may own an individual policy or a survivorship policy covering two people, typically spouses. The appropriate structure depends on the family’s estate planning goals, insurance needs, beneficiaries and the terms written into the trust agreement.
The outcome depends on the trust agreement and the life insurance policy. Because ILITs are designed as long-term arrangements, the trust document should address policy maturity, termination provisions and distribution of remaining assets. These terms should be reviewed before establishing the trust.
Yes. However, transferring an existing policy creates an important three-year rule. If the insured dies within three years after the transfer, the death benefit may be brought back into the taxable estate. Having the ILIT purchase a new policy avoids this transfer issue.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Bennett Thrasher’s Trusts & Estates Planning, or call us at 770.396.2200.
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