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What is an ILIT?

An Irrevocable Life Insurance Trust (“ILIT) is a trust that owns a life insurance policy on your life.

Why do I need an ILIT?

There are many reasons why you want to put life insurance into a trust rather than have an adult beneficiary own the coverage:

1. Life Insurance proceeds can be used to accumulate cash to provide for retirement nest for your spouse or a fund to pay college tuition for your children.

There is a lot of flexibility on how the money is invested or used.  For example, you can provide the trustee “sprinkling” powers so that s/he can make additional payments to beneficiaries who need extra money because of a medical emergency, a divorce or tuition expenses. 

2. You can avoid the appointment of guardianships or a conservatorship for your beneficiaries

If your children receive the insurance proceeds as either primary beneficiaries of your insurance policy, (or secondary beneficiaries in case of the premature death of your spouse), and they are minors, or incapacitated, a guardianship will have to be set up to hold the proceeds until they are 18.  You will have no control over how the proceeds will be used – rather the court will decide how the proceeds will be used.  The ILIT will put control back in your hands: the trustee will receive the proceeds and provide for this person's care for as long as needed as you provide in the trust.

3. You can ensure that the premiums will be maintained and the proceeds used for the purpose for which the policy is intended

This assurance is especially important if you are worried about the soundness of a child’s marriage and the possibility that the child’s spouse could reach the policy cash values in the event of a divorce or if there are creditors of the child. 

This is especially important if that child is in business. For instance, if the life insurance is crucial to pay taxes so that a family business will not have to be sold to raise tax money or if you want to prevent a forced sale of real estate that your family has owned for generations, you may not want to risk that the money will not be available. If you make an outright gift of the insurance, instead of placing it in an irrevocable trust, an adult child might cash in the policy or borrow against the cash values.

4. Avoidance of having life insurance proceeds being included in your taxable estate when you die. 

Life insurance proceeds, even if payable on your death to a 3rd party – for example, your children - will be subject to estate taxes if you owned the policy at your death.  If you are married and you leave the proceeds to your wife, any remaining insurance proceeds will be included in his or her estate when s/he dies.  By purchasing the insurance through a life insurance trust, the proceeds will be excluded from BOTH spouse’s estates. 

5. Providing a source of funds to pay for estate tax and bills on death without having to liquidate assets.

When a person passes away, the survivors need a source of funds to pay for last medical bills, funeral costs, support for the survivors, and often estate taxes, which are due nine months after death - in cash.  The need to generate enough money in cash from people who have substantial wealth in illiquid assets, such as closely-held businesses, their home or other real estate, can devastate many estates.

Life insurance proceeds become available immediately upon death to pay for estate taxes and bills, thereby avoiding having to quickly liquidate your property at fire sale prices to pay estate taxes.

6. Enable you to have a higher standard of living

There is still one more major advantage to placing life insurance in an irrevocable trust. If you can be sure that your beneficiary(ies) is well provided for—because of the life insurance in the irrevocable trust—you may feel free to use other assets to attain a higher standard of living now.  Spending more of your assets now also has the collateral benefit of reducing the size of your taxable estate. So creating an irrevocable life insurance trust can help you save estate taxes, pay estate taxes, and in a sense gives you the freedom to fully enjoy the assets you presently own.

7. Asset Protection

If your heir had financial problems, such as an IRS problem or a bankruptcy, the insurance would be seized by his or her creditors.  You probably trust this person now, but you never know what problems may crop up later.

On the other hand, an insurance trust is a safer alternative. You would still name the same one or more heirs as the trustee(s) to take out the policy and run the trust (generally the same as the successor trustee(s) under your living trust).  However, the trustees would have a duty to act properly and could not change who would get the money in the end.  Moreover, if any trustee had financial problems, their creditors could not touch the insurance trust assets. Therefore, the insurance trust allows you to better assure that your intent is carried out.

How Does an Insurance Trust Give Me Control?

With an insurance trust, your trust owns the policy.  No one can change your trust. The trustee you select must follow your instructions. With your insurance trust as beneficiary of the insurance policies, you actually have more control over the proceeds.

For example, you could direct the trustee to use the proceeds to purchase assets from your estate or revocable living trust, providing cash to pay expenses.  You can provide your spouse with a lifetime income and keep the insurance proceeds out of both of your estates. You could also keep the proceeds in the trust and give periodic distributions to the beneficiaries of your insurance trust.

By contrast, if your spouse is beneficiary of the policy and you die first, all of the proceeds will be included in your spouse's taxable estate. This could create a tax problem. If your children are beneficiaries of the policy, they will receive all the proceeds right away.  And you have no control over how they are used.

Who Can Be Beneficiaries of the Insurance Trust?

You can name any person or organization you wish, but most people name their children and/or spouse.

Can I Be My Own Trustee?

Not if you want the tax advantages mentioned above. If you are the trustee, the trust is taxed by the estate tax.  You must name another person as trustee.  The trustee can be anyone you choose.  Some people name their adult children as trustees. Others choose a bank or trust company because of their experience.

Can My Wife Be Named Trustee of my Single-Life Policy?

Yes, but if you wish the policy proceeds to escape tax when your spouse dies, his or her powers as trustee have to be restricted

Can I Transfer My Existing Policies to the Trust?

Yes. If you die within three years of the date of transfer, it will be considered invalid by the IRS and the insurance will be included in your taxable estate.  There may also be a gift tax.  However, there are ways to either avoid or minimize the risk of this happening.

Where Does the Trustee Get the Money to Purchase the Insurance?

From you, but in a special way.  If you transfer the money directly to the trustee, it could be subject to a gift tax.  However, you can give up to $12,000 to each beneficiary of your trust with no gift tax. You and your spouse together can give up to $24,000 per beneficiary.

But instead of making the gift directly to the beneficiaries, you give it to the trustee for them. The trustee then notifies each trust beneficiary that a gift has been received on his or her behalf and, unless he or she elects to receive the gift now, the trustee will invest the funds -- by paying the premium on the insurance policy. Of course, the beneficiaries must understand not to take the gift now.

Do I Have To Set Up an ILIT for Each Policy I Own?

No, a single ILIT can hold more than one policy.

What If I Believe Life Insurance Is Not The Greatest Investment?

Not all people are comfortable with life insurance.  But because life insurance in an insurance trust pays out free of both income and estate taxes, it must be seriously considered as the best investment for many people as far as the net dollars in the end that will go to the heirs.

What are the Disadvantages of Life Insurance Trusts?

A.        There are a relatively few (but perfectly sound) reasons why you may not want to transfer preexisting life insurance into an irrevocable trust or to have the trustee purchase new insurance on life. These disadvantages include the following:

•           The arrangement is more complicated and requires more attention to detail than if your beneficiaries owned the insurance outright on your life.

•           You lose the ability to reach the policy cash values of contracts that the trust holds, though the trustee may be able to “loan” you money from the cash value/

•           You cannot use trust-owned life insurance policy cash values as collateral for personal or business loans,

•           While ordinarily you can no longer name new policy beneficiaries or remove those presently named, or change the size or terms of a life insurance policy beneficiary’s interest, the IRS have allowed a trustee to transfer existing policies to a new policy with new beneficiaries. 

•           There are up-front and continuing costs involved with an irrevocable life insurance trust, even if the trustee “isn’t doing anything.” First, there are legal fees for preparing the trust agreement. Expect attorney’s costs to range from a low of $2,500 to more than $10,000, depending on the nature and extent of your assets and the part the irrevocable trust plays in the overall planning process in your estate. (Always demand a written estimate of overall costs and hourly fees—before any work is done.)

            Second, there are accounting and investment costs. Of course, if the trust has no income, no tax returns will be required. Until you put income-producing property in the trust or until your death, tax return preparation costs should be nil. Likewise, until there are assets in the trust other than life insurance policies, no investment expertise is required. Nevertheless a trustee has set-up costs and annual record-keeping expenses. In addition, documents

Can I Make Changes to the Trust – “Escape Valves”

Unfortunately, once the trust is signed, you cannot make any changes. The trust is irrevocable. However, our trusts can contain “escape valves” which will give an “independent trustee” the power to terminate the trust, or to change the trust provisions (and even beneficiaries). 

When Should I Set up an Insurance Trust?

You can set one up any time, but because the Trust is irrevocable, many people wait until they are in their 50s or 60s.  By then, family relationships have usually settled - and you know whom you want to include as a beneficiary.

Just don't wait too long -- you could become uninsurable. Also, if you transfer existing policies to the Trust, you must live at least three years after the transfer for it to be valid.

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