ILIT: Irrevocable Life Insurance Trust
An irrevocable life insurance trust (ILIT) holds the insurance premiums that you invest in an insurance policy for the benefit of people you want to take care of in the future. This irrevocable trust arrangement works well for people who want to avoid estate taxation and provide a legacy for children or grandchildren. Today there is another compelling reason to consider an irrevocable life insurance trust: the need to plan for long term care.
Let's compare the ILIT with the usual arrangement, where you hold ownership of an insurance policy. If the insurance policy is owned by you, the value of the life insurance policy will be included in the calculation of the estate tax on your estate. This could cause a significant estate tax liability if you have a taxable estate. Also, ownership of a life insurance policy would be counted against you if you or your spouse need eligibility for Medicaid to pay for nursing home care in the future.
An insurance policy owned by an irrevocable trust is not owned by you; the policy is owned by the trustee of the ILIT. The ILIT trustee takes money you contribute to the trust, and uses it to pay the premiums to the life insurance company. These transfers to the ILIT trustee are covered by your annual gift tax exclusion. Your gift transfer of money to the ILIT:
- reduces the size of your estate, and reduces or eliminates estate taxes;
- protects the money you invest in your life insurance policy from creditors;
- eliminates the need for Probate, since the proceeds of the ILIT are transferred privately by the insurance company, to the people you designate;
- allows you to control who receives the proceeds from your life insurance policy
- eliminates the value of the policy from being counted against you or your spouse, as long as the premiums for the policy owned by the irrevocable trust have been fully paid before you need Medicaid to pay for long term care.
People who set an an ILIT can use their annual exclusion amount, and transfer funds to the trust with no estate or gift tax consequences. Besides protecting your estate from estate taxes, and the cost of long term care, other goals can be achieved by an ILIT:
- protecting the eligibility of another family member who receives government benefits;
- scheduling distributions from the ILIT for a beneficiary who needs money for college tuition, graduation, or down payment for a home;
- flexibility that allows for distributions of money if a beneficiary starts a business, gets married, has a child or for other special needs that you designate.
Anyone can establish an ILIT. You decide on what is important to you, and we will plan the ILIT to fit your specific goals and intentions. Here are the steps to take:
- Consider the people you want to benefit from your ILIT, and chose initial and successor trustees
- Get a medical examination to confirm that you can actually be insured under the insurance policy you have selected. Don't sign anything, except as a person who is to be insured. Don't sign as an owner of the insurance or as the applicant for the insurance policy;
- We'll draft the trust;
- You and your trustee sign the insurance trust;
- Your trustee applies for the life insurance policy and signs an application as owner of the insurance policy;
- The life insurance application should not be filed until you make an initial gift to the ILIT to cover the premium that is held in the ILIT's checking account. Your trustee notifies your beneficiaries that a gift is being made to the ILIT and they have rights of withdrawal (known as Crummey powers) ;
- After the time period for withdrawals has lapsed, payment of the premium can be sent to the insurance company.
For a blended family, the ILIT can provide a flexible way to prevent conflict when a person is survived by children from two marriages.
Example: A Husband and Father Protects His Blended Family With an ILIT
Dr. Roger Cardigan and Eileen Cardigan have been married for thirteen years, and they have three young children. Roger also has two older children from a previous marriage.
Although everyone gets along well now, Roger is concerned about being fair to his older children. He wants to remember them with a meaningful inheritance, while also leaving as much income as possible for Eileen and his three younger children. These goals present a planning challenge.
Roger considered using the QTIP trust that Mr. Quinones had selected. The QTIP would allow him to leave income for Eileen for her life, and then have the remaining assets go to his older children upon Eileen's death. But, there are serious drawbacks.
Roger wants to leave assets outright to Eileen that are not tied up in a trust. He's also worried that there won't be enough assets to go around. If Roger's assets are exhausted by Eileen during her life, his older children from the prior marriage would get nothing.
Even if there are enough assets left for the older children, there would be a timing problem with the QTIP Trust. Roger does not want his older children to have to wait until Eileen's death to receive their inheritance. That would be an invitation to resentment.
The solution for Roger is life insurance that is owned by an irrevocable life insurance trust. The ILIT allows Roger to balance the needs of Eileen, and his two older children.
Roger would use some of his current income to pay the premiums on life insurance that will be owned by the trust. When Roger dies, the ILIT will:
- provide an immediate death benefit to his older children from his first marriage. (they won't have to wait to receive their inheritance)
- help with plans to avoid Federal and Massachusetts estate tax at Roger's death
- help eliminate friction between them and their stepmother Eileen (the older children won't be able to complain about how Eileen is spending or investing the money needed for her lifetime support).
- make all of Roger's other assets available to support Eileen and the younger children.