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Possessing a life insurance policy is a means to secure financial resources for your loved ones upon your passing. However, if your estate is large enough and your life insurance policy gets included in your estate, it may be subject to estate taxes. This would reduce the amount of money passed to your beneficiaries.
Creating an irrevocable life insurance trust (ILIT) is one way to make sure your life insurance policy doesn’t get included in your estate when you pass away.
What is an ILIT?
An ILIT is a legal arrangement that allows an individual, known as the grantor, to place a life insurance policy into a trust, giving them greater control over how the policy’s proceeds are distributed and taxed. The trust becomes the policy owner and beneficiary. The grantor can’t alter or revoke the trust once it’s established. The trust is managed by a trustee, who is responsible for administering the trust and carrying out the wishes of the grantor.
Benefits of ILITs
Placing a life insurance policy into an ILIT can help reduce estate taxes. Since the trust owns the policy, the death benefit is not considered part of your estate and may be excluded from estate taxes.
Assets held within an irrevocable trust, such as an ILIT, are generally shielded from creditors. By placing a life insurance policy in an ILIT, you can protect the policy proceeds from potential claims, providing financial security for your beneficiaries.
With an ILIT, you can specify how the life insurance proceeds will be distributed. For instance, you can stagger distributions to beneficiaries or provide for certain conditions before funds are released, ensuring that the proceeds are used as intended.
Unlike a will, which becomes public after probate, an ILIT maintains privacy since the trust document is not made available to the public. This confidentiality can benefit you if you prefer to keep your financial matters private.
Potential Drawbacks to ILITs
Once the life insurance policy is placed in an ILIT, you relinquish control over the policy. You can’t change beneficiaries, alter terms, or revoke the trust. This loss of control may be a disadvantage if you desire flexibility in your estate plan.
Establishing and maintaining an ILIT requires legal and administrative expertise. Professional assistance is often necessary, which can lead to additional costs. The complexity involved in managing the trust may also pose a challenge for some.
Funding an ILIT involves making a gift to the trust beneficiaries. This can trigger gift tax implications, depending on the amount gifted and your lifetime gift tax exemption. It’s important to consult with a tax professional to understand the potential tax consequences.
Since an ILIT is irrevocable, it can’t be easily modified to adapt to changing circumstances. Life insurance needs may change over time, and once a policy is placed in an ILIT, it becomes difficult to make adjustments without potentially adverse tax consequences.
Weighing the Pros and Cons of ILITs
ILITs can be a valuable tool in estate planning, offering tax benefits, asset protection, and control over distribution. However, they come with some potential drawbacks, including loss of control, complexity, and potential tax implications.
It’s crucial to consult with an estate planning attorney to assess whether an ILIT aligns with your specific circumstances and goals. Understanding the basics and weighing the pros and cons will help you make an informed decision when considering an ILIT as part of your overall estate plan.