How Irrevocable Life Insurance Trusts Work
Irrevocable Life Insurance Trusts are really not complicated, despite how they may appear. In this blog, we’ll discuss what you need to know about them, in simple terms.
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Irrevocable life insurance trusts – what you need to know
What is an ILIT?
An Irrevocable Life Insurance Trust, or ILIT, is a trust that is established to hold a life insurance policy. Assets held in an ILIT are not included in the grantor’s taxable estate and therefore avoid estate taxes altogether. However, an ILIT is an irrevocable trust. Once the life insurance policy is placed into the trust, it can’t be changed. If family circumstances change, the beneficiaries named in the ILIT can’t be changed.
The illustration below shows how the life insurance policy held in the ILIT bypasses a family’s taxable estate.
Source: Advisys, Inc.
As of today, as you can see above a married couple can pass $13,990,000 dollars each, or $27,980,000, tax free to the next generation. On January 1st this amount will jump to 15 million dollars per person, or 30 million dollars per couple. This 30 million dollars will go up annually by the inflation rate.
Why use an ILIT?
People use ILITs when they have an estate that is large enough to be taxable and they want to reduce their estate tax burden. For example, if after January 1st 2026 a married couple had a 40 million dollar estate (10 million more than they can pass free of estate tax) and they died in a plane crash, their estate would owe roughly 4 million dollars in estate taxes. This is 10 million multipled by roughly 40%, which is the tax rate on the value of the estate that exceeds 30 million.
In order to pay these estate taxes, some couples decide to buy a second-to-die life insurance policy and have it be owned by the ILIT so it’s not included in their estate. They then give personal funds to the ILIT to pay the life insurance premiums. There are specific rules that have to be followed when gifting funds to the ILIT, but they are not difficult to follow.
Second-to-die policies are much less expensive because both husband and wife have to pass away before the benefit is paid out. A five to ten million-dollar policy can be relatively inexpensive, especially for somebody in their 50s; however, it depends upon your personal circumstances, health status, etc.
We are not normally advocates of using life insurance as an investment vehicle, but in this case a second-to-die policy can make sense. Because we do not sell insurance or make commissions on any financial products, we can help our clients find suitable insurance policies to fund their ILITs without any conflicts of interest.
Got a large, taxable estate?
If estate taxes are something you are concerned about, there are many strategies available to you to try to reduce your estate tax liability. An ILIT is a relatively simple strategy to put in place that can be used in combination with other more complicated strategies. But as a note, please do not interpret anything we have said in this article as a recommendation specific to any one individual. Everything contained herein is guidance that is general in nature. Please contact your legal, tax, or financial advisor for guidance that is specific to you.
And on that note…
We are financial advisors in La Jolla, California. If you want to discuss your overall financial plan or retiring in California or other locations, please reach out to us and set up a time to talk.