Understanding Irrevocable Life Insurance Trusts

An Irrevocable Life Insurance Trust, commonly known as an “ILIT,” is a highly effective estate planning device that removes life insurance proceeds from an individual’s taxable estate.   The death benefit from a life insurance policy owned by an ILIT can also be used for the needs of a deceased individual’s spouse and/or descendants without the necessity of probate.

How is an ILIT Established?
Typically the Grantor of the ILIT gifts an existing life insurance policy to the ILIT or gifts money to the ILIT to be used to purchase life insurance.   The life insurance policy may insure the Grantor’s life or, in some circumstances, the lives of both the Grantor and the Grantor’s spouse.  When the insured individual dies, the ILIT’s trustee collects the death benefit and administers those funds for the ILIT’s beneficiaries.

How Does an ILIT Compare to a Revocable Living Trust?
Unlike a revocable living trust, the Grantor of an ILIT should not have the power to revoke or amend the trust or control its assets (so that the ILIT’s assets are not included in the Grantor’s taxable estate). Both a revocable trust and an ILIT can be part of a comprehensive and well-designed estate plan.

Who Should Be The ILIT’s Trustee ?
The Grantor of the ILIT should not serve as trustee in order to avoid the life insurance proceeds being included in his or her taxable estate. If the ILIT owns a second-to-die insurance policy, neither the Grantor nor his or her spouse should serve as trustee. However, in the case of a single-life policy, the Grantor’s spouse may serve as trustee provided that the benefits to the surviving spouse are limited to an ascertainable standard- typically the spouse’s health, education, maintenance and support.

Does a Surviving Spouse Benefit from an ILIT?
A surviving spouse may receive distributions from an ILIT for his or her health, education, maintenance and support. The surviving spouse may also withdraw up to five (5%) percent of the principal per year. The surviving spouse may also benefit from an ILIT’s creditor protection and insulation from risks associated with remarriage.

Can Existing Life Insurance Policies Be Transferred Into the ILIT?
While the transfer of an insurance policy to an ILIT is a taxable gift, no gift tax will be due so long as the value of the policy does  qualifies for the annual exclusion.  However, an existing policy that is gifted to an ILIT will be included in the prior owner’s taxable estate unless the prior owner has given up all ownership rights in the policy at least three (3) years before death.

Who Should Prepare an Irrevocable Life Insurance Trust?
Only a qualified estate planning attorney should prepare an ILIT, although an attorney will often coordinate with the client’s certified public accountant and life insurance professional.

Charlotte-based attorney Christian Perrin is a North Carolina Bar Board Certified Specialist in Estate Planning and Probate Law.  Based in Charlotte, Christian and his team serve clients throughout North Carolina and South Carolina. 

Disclaimer: This information is intended to stimulate thought and discussion and to provide readers with useful ideas in the area of estate planning.  However, this information does not constitute and should not be treated as legal advice or tax advice regarding the use of any particular estate planning technique, device or suggestion.  Our law firm does not assume any responsibility for any individual’s reliance on the information presented.  Each reader should verify independently all statements made before applying them to a particular fact pattern and should determine independently the legal and tax and other consequences of using any particular device, technique or suggestion.