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Life Insurance Trusts

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Irrevocable Trusts

This means you don’t have freedom to alter the terms of the trust after its creation. 

Irrevocable Life Insurance Trust (ILIT)

An irrevocable trust commonly used in estate planning for holding a life insurance policy or to transfer assets to others during the settlor’s life. You probably know that life insurance proceeds are included in your estate and this may subject you to estate taxes typically in 45% range. I.R.S. will include the life insurance proceeds in your taxable estate if:

  1. You own the policy, i.e., you bought it.
  2. The premiums come from your assets.
  3. You have the right to change, affect or prevent the change of beneficiary.
  4. You have the right to borrow against the policy.
  5. The right to repurchase insurance from an assignee (the person you assigned the rights to the policy to).

So, much of the money you were hoping to support your family with would go for taxes. Perhaps you thought the life insurance proceeds were “estate tax free” because the salesperson told you they were “free of income tax”? An easy mistake to make! One way to avoid this is to have another person, such as your child or the spouse own the policy. But, where is the money for premiums going to come from? If any of it is yours (typically the case in a community property state), the policy will be included in your estate. Also, a child may die, the policy may get attached, divorce causes problems, etc. Hence, the Irrevocable Life Insurance Trust (ILIT). The trust has the settlor’s (one whose life is insured), the trustee (usually your spouse) and the beneficiaries (the spouse, the children, etc.).The first year premiums are given to the trust (these transfers are irrevocable) and gifts are also made to pay the premiums for the subsequent years. The annual gift exclusion makes it possible to avoid gift tax on these contributions. Be careful if you transfer an existing policy into an ILIT. For the first three years after the transfer, it would still be included in your estate and be subject to estate taxes. You are far better off to buy new policy with the money transferred into an ILIT. Upon the settlor’s death the trustee provides for the surviving spouse to live in the style he or she had become accustomed to. Upon the surviving spouse’s passing the remainder of trust assets are distributed to the beneficiaries. So, in addition to having two estate tax exemptions (presently at $1,500,000 per person), you also have life insurance free of estate tax. 

Hopefully, this explains the way your life insurance can be kept out of your estate with corresponding savings in estate tax and more money for your family.