An Irrevocable Life Insurance Trust (ILIT) creates a pool of money outside of the estate to offset estate taxes and provide more efficient wealth transfer between generations.
An ILIT is a very popular estate-planning tool designed to own life insurance outside the estate of the grantor(s). The trust makes life insurance death benefits available to pay estate taxes. This way, valuable estate assets do not need to be liquidated to generate cash, and family wealth is not eroded.
Mechanics of an ILIT
Typically, the grantor(s) create the ILIT which then purchases life insurance on the lives of the grantors. If the grantors are a married couple, survivorship (second-to-die) insurance is usually the product of choice because of its affordability and the likelihood (in many instances) that the greatest need for cash will occur upon second death. For an unmarried grantor, single life products are used.
The ILIT is the applicant, owner, and beneficiary of the life insurance policy. The grantor(s)’ heirs are beneficiaries of the ILIT, and the grantor(s) are typically the insured(s). The trustee must not be the grantor(s) but can be a trusted individual or an institution. It is very important that all incidents of ownership of the life policy belong to the trust and not to the insured(s) so as to avoid estate inclusion at the insured(s) death.
The trust should have its own checking account, and the trustee writes premium checks from that account. The ILIT generally receives the money to fund that account through annual gifts from the grantor(s). These gifts are typically excluded from gift taxes by the annual gift tax exclusion if the trust provides the beneficiaries with special withdrawal rights called “Crummey Powers”.
Upon the Death of the Insured(s)
At the grantor(s)’ death, the ILIT, as beneficiary of the policy, receives the death benefit. The ILIT, operating for the benefit of the children, can purchase desired assets from the grantor(s)’ estate thus enabling the children to own those assets while also providing the estate with cash for estate taxes. The ILIT could also loan money to the estate to pay estate taxes. This way, the estate can avoid forced liquidations. In essence, the ILIT uses the death proceeds to provide liquidity to the estate so as to avoid a forced liquidation of estate assets to non-family members.
In a classic ILIT, once money is gifted into the trust, it cannot be recovered by the grantor(s). Many grantor(s) are comfortable with this loss of access, but for those grantor(s) who desire some level of access to trust assets, other options should be considered.
For the creation of any type of ILIT, a qualified estate-planning attorney is required.