Irrevocable Life Insurance Trusts (ILIT) Explained

Trust Elements:

Grantor: This person creates the trust and transfers their property to the care of a trusted fiduciary, the trustee.
Trustee: The person or organization that acts as a custodian for the assets held in a trust. They are responsible for managing and distributing assets according to the instructions set by the grantor in the trust document.
Beneficiary: This person(s) benefits from the trust in some way.
Property: Almost anything of legal ownership, real estate, bank accounts, stocks and bonds, jewelry, life insurance policies, etc. can be transferred to and held in a trust. Also called the trust corpus or principal.
Terms: Trust terms, or powers, establish the responsibilities and duties of the trustee. It also includes distribution instructions, any clauses or provisions, and appointments for a successor trustee if the present trustee is unable or unwilling to perform their duties.

Primary Types of Trusts

There are many types of trusts, each performing a variety of functions.

The three overarching types of trusts include:

Living Trust: Created while you are alive, a living trust enables you to manage your assets during your lifetime. It provides details on how the assets should be distributed after your death.
Testamentary Trust: Created through your will, this trust only comes into effect after your death. It outlines how assets will be managed and distributed for the benefit of specific individuals or purposes.
Charitable Trust: This type of trust holds and manages assets specifically for the benefit of a charity. This trust can have many tax incentives and financial benefits for the grantor.

A trust can be established as revocable or irrevocable.

Revocable Trust: A revocable trust allows the grantor to keep control over the assets within the trust while alive. Assets can be transferred or revoked at any time during the lifetime of the grantor. Although assets in a revocable trust avoid probate, they are still subject to estate taxes.
Irrevocable Trust: Once assets are placed into an irrevocable trust, the grantor loses control over them and cannot terminate the trust or reclaim the property. Assets within an irrevocable trust bypass both probate and certain taxation.

What is an ILIT and why put life insurance in it?

An irrevocable life insurance trust (ILIT) is a specific type of living trust, irrevocable in nature, and often used for strategic estate planning. It’s created to hold term or permanent life insurance policies while the insured is alive.

The ILIT is the owner, payor, and beneficiary of the life insurance policy.

You, the grantor, fund the trust and the trustee uses this money to pay the life insurance premiums. Upon your death, the life insurance policy death benefits are paid to the trust and the trustee manages and distributes the payouts to your beneficiaries according to the terms you set in the trust.

Here are the primary reasons you might consider creating an ILIT:

Estate Tax Reduction: Keep life insurance proceeds out of taxable estate to lower estate taxes.
Asset Protection: Shield policy value from creditors and legal claims.
Controlled Distribution: Determine how and when beneficiaries receive proceeds.
Charitable Giving: Include provisions for directing funds to charitable causes.
Avoid Probate: Simplify asset transfer by bypassing probate.
Preserve Privacy: Maintain financial privacy as trust terms remain private.
Provide Liquidity: Offer funds for estate settlement costs without selling assets.
Support for Blended Families: Establish clear instructions on distributing insurance benefits (and other assets) among children from different relationships.
Special Needs Provision: Provide financial support while protecting the needs-based government benefits of loved ones with special needs.
Tax Efficiency: Minimize estate, income, gift, and generation-skipping transfer taxes for both the grantor’s estate and beneficiaries.
Long-Term Planning: Structured approach to wealth preservation and legacy planning.

By placing your life insurance in an ILIT, you ensure that the policy’s benefits align with your specific wishes, financial goals, and family dynamics. It offers a controlled and protective way to manage the insurance proceeds, particularly valuable if beneficiaries may struggle with managing large sums or if there are complex family relationships involved.

Are there downsides to an ILIT?

The main disadvantages of putting property into an ILIT, or any irrevocable trust, include:

Losing Control Over Assets: Once assets are placed in an ILIT, you lose control over them. For permanent life insurance policies with cash value, this loss of control includes not being able to access that cash value.
Inflexibility: Once established, an ILIT’s terms generally can’t be changed.
Costs and Complexity: Establishing an ILIT can be a time-consuming process that may require legal and professional guidance due to its complexity. The associated legal fees and consultation costs can add to the overall expenses of creating the trust.

It’s important to note that, in some cases, an irrevocable trust can be dissolved by the court.