An irrevocable life insurance trust (ILIT) gives you more control over your insurance policy and how your beneficiaries will get the death benefit when you die. A life insurance policy is an investment and an asset. So, it will be part of your estate after you die. Because of this, the death benefit, or proceeds, can be subject to an estate tax if all of your assets are worth more than the federal exemption limit.
How ILITs Work
In estate planning, a trust is a separate entity that holds your assets, such as money, real estate, and personal items. So that they can be given to your heirs after you die. An ILIT is a trust that you can’t change your mind about. It holds your life insurance policy for you so that it doesn’t count toward your taxable estate.
The trust is the policyholder, so you don’t have to worry about anything to do with ownership. The death benefit is no longer part of your estate and does not add to the value of your estate for tax purposes. It also won’t have to go through probate, which is the legal process of getting your estate in order. Your heirs can get the full amount of the death benefit. Here’s the process:
- You set up your ILIT
- You give your existing life insurance to the trust, or you have the trust “buy” a new policy. Then you put money into the trust so it can pay your premiums.
- The trust is the beneficiary of your life insurance policy. So when you die, the policy pays the death benefit to the trust. The benefit is not counted toward your estate tax.
- The ILIT will give your trust’s beneficiaries the death benefit based on your instructions. Which are written in the trust document.
Setting Up An ILIT
ILITs are hard to understand and have many tax effects. When setting up a trust, it’s important to talk to an attorney to make sure it’s done right and works to your advantage. Once you’ve started putting together the trust you’ll find there are 3 designations that need to be made:
- Grantor – You, the person who makes the trust
- Trustee – The person you elect to manage the trust for you
- Trust Beneficiaries – The people you have chosen to receive your assets listed in the ILIT after you have passed away
To actually set up the ILIT you have a few steps. First, you open and finance the ILIT and fund the trust to keep up with the premiums for your life insurance policy. Second, you’ll transfer or buy a new life insurance policy into the trust. Lastly, you’ll select a trustee and choose how the ILIT will distribute the benefits. Be careful as these instructions can not be changed later.
Benefits Of ILITs
Using an irrevocable life insurance trust can help you save on taxes and give you more control over how the death benefit from your life insurance is used.
Minimizing Estate Taxes
If you have a life insurance policy when you pass away, the death benefit is considered an asset. So, it is added to the total value of your estate. However, if you put the life insurance into an ILIT, the money from your death benefit would not be counted as part of the estate and will not face taxes. If you don’t include your life insurance, you may also be able to lower the total value of your estate before the federal exemption level and avoid paying taxes on it.
Death Benefit Can Pay Estate Taxes
All of the money and things you own make up your estate. If your estate is worth more than the amount the law says is exempt, federal estate taxes will have to be paid. In 2020, the amount that won’t be taxed is $12.92 million. This means that a person can leave $12.92 million to their heirs without having to pay any estate taxes at all. Also, if the two people are married, the exemption would double to $25.84 million. If the trust is set up right, the money from your death benefit can be used to help pay taxes on your other assets.
For example, let’s say you have a $15 million estate made up of real estate, retirement accounts, and stocks. Your beneficiaries would have to pay estate taxes for that amount. Your trustee could pay that tax with the money from your death benefit. This lets you beneficiaries get the full value of all other assets outside of the ILIT.
State Estate Taxes
Even if you don’t have to pay the federal estate tax, depending on where you live, you may still have to pay the state estate tax. When compared to the federal level, the amounts that are exempt from these estate taxes are much lower. Here are the states that charge an estate tax and their asset exemption limits:
- Connecticut – $12.92 million
- Hawaii – $5.49 million
- Illinois – $8 million
- Maine – $6.41 million
- Maryland – $5 million
- Massachusetts – $12.92 million
- Minnesota – $3 million
- New York – $6.58 million
- Oregon – $1 million
- Rhode Island – $1,733,264
- Vermont – $5 million
You Control The Benefits
With a trust, you, as the grantor, can give specific instructions about how the death benefit will be used. Usually, the beneficiary gets the money from a death benefit in one lump sum or several payments over a set amount of time. With an ILIT, you can give extra instructions. Like holding back money if the beneficiaries are too young. Or even setting aside portions of the money into investment accounts that can be accessed later. Having the money from a life insurance policy owned by an ILIT can help protect the benefits of a trust beneficiary who gets government help. Like Social Security disability income or Medicaid. The Trustee can keep a close eye on how the trust’s money is spent so that it doesn’t affect the beneficiary’s ability to get government benefits.
Disadvantages of ILITs
ILITs could help people reach certain tax and estate planning goals, but ILITs can also have the following problems. Before starting an ILIT, think about these things.
Once you give your life insurance policy to an ILIT, you can’t give it to another trust or entity. This is because you’ve given up all rights to your coverage. Imagine you set up an ILIT and named your spouse as a beneficiary. After a few years, you get a divorce and want to take your spouse off the policy. There is no easy way out of this situation unless specific language was added before the trust was put into action.
If you die within the first 3 years of setting up your ILIT, the trust’s life insurance policy may be automatically added to your estate. If the payout from your life insurance is part of your estate, it could be taxed along with the rest of your assets.
You Don’t Own Your Life Insurance
With an irrevocable life insurance trust, the policy is owned by the trust and not by you. Most of the time, you can’t change your life insurance policy after you set up an ILIT. Your trustee is in charge of making sure that your policy is managed and paid out according to the rules of the trust.
Choosing Life Insurance
If you are setting up an ILIT and choosing a new life insurance policy at the same time, you are in a great position to choose the best policy for your needs. This could be a term policy, which lasts a specific amount of time. However, it’s more likely with an ILIT that you will choose a whole life policy. The good news is, there is no rule about what kinds of life insurance you should include in your ILIT. To make sure you get the results you’re aiming for you may want to work with a lawyer, a financial advisor, and an insurance agent. Among the three, you’ll make sure all your bases are covered when you set up your ILIT.
Who Should Get an ILIT
ILITs are best for people with a high net worth who want to avoid paying higher estate taxes if they don’t have to. Parents who want the money to go to their minor children can also use an ILIT. This makes sure that the money goes to care for their children and doesn’t get stuck in court.
Most people won’t need to include the complexity of an ILIT in their end-of-life planning like paying for a funeral or cremation. So a strong will, a revocable trust, and an insurance policy will be enough for their estate plan. Since the trust can’t be changed once it’s set up. It’s best for people who have special needs when it comes to estate planning.
Working With EZ
Your family will still have bills to pay after you die, and they will need your help more than ever. The last thing you want them to worry about while they are grieving is money. There are many great options for low-cost life insurance that will give your family enough money for a low monthly price. Working with an agent who specializes in life insurance is the best way to find the right policy for you and your needs. At EZ.Insure, we know that you and your family want the best coverage but we also know you have to stay within your budget.
So, we will do everything we can to find you the best policy at the best price and we want to make it as easy as possible for you to do so! We’re here to help, and the best part is that everything we do is free. We will help you with everything, from answering all of your questions to helping you choose a policy and finish the enrollment process. We will also help you after your plan has started. To get started, just type your zip code into the bar below or give us a call at 877-670-3560.