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Horizon Elder Law & Estate Planning Blog

Thursday, March 15, 2018

What is an Irrevocable Life Insurance Trust?

Although it is sometimes overlooked, a life insurance plan is a valuable piece of your estate plan. In fact, it is one of the most common financial products in the United States. Its benefits are easy to understand, but the administration of life insurance funds is less straightforward. A California estate planning attorney will tell you that life insurance proceeds are extremely valuable to a family that has just lost a loved one, but they can also be cumbersome if not managed properly.

Life Insurance Trusts: The Basics

A life insurance trust is developed simply to hold your life insurance policy and proceeds to you. There are several benefits to doing this, but the most prominent reason that individuals use this device is that it removes the life insurance benefits from your estate.

Removing your life insurance benefits from your estate can significantly reduce your estate taxes. Because life insurance policies are often substantial, adding them to your estate could push you over the exemption limit.

You can still somewhat control your life insurance plan while it is in the trust, but it is done indirectly. You will choose who the beneficiaries will be and the terms of their receipt of benefits. However, once you set out this information, you cannot change it. You can also name your trustee to manage the trust as well. Unlike some other trusts, you cannot be the trustee if you want to reap the benefits of an irrevocable life insurance trust (ILIT).

Benefits of an ILIT

Once the life insurance proceeds are dispersed, the trust acts as a testamentary trust. That means that you can dictate how and when your beneficiaries will get the funds, just as you in any other type of trust. As a result, the benefits of a regular trust generally apply to ILITs. For example, this type of trust will:

  • Allow you avoid a situation where you are leaving money to a beneficiary who is on government aid

  • Reduce the size or your estate

  • Reduce the amount of insurance coverage you may need by decreasing your potential estate taxes

  • Allow you to set the terms for when and how your beneficiaries receive the life insurance funds

  • Protect the value of the policy from creditors

A sudden influx of cash can be overwhelming, even for an adult. However, if you are leaving minors life insurance money, then a ILIT allows you to administer those funds on behalf a child as well.

Complications to Consider

The IRS understands that many people use an ILIT to avoid having to pay estate taxes. For that reason, they set a time limit associated with the transfer of a life insurance policy to a trust. If you pass away within three years of putting the insurance policy in the trust, then the IRS will likely still include the proceeds of the plan in your estate and tax you on it.

You may also need to consider whether there are gift taxes associated with the trust.

Your estate planning lawyer can help you deal with these potential issues. Contact the professional estate planning attorneys at Horizonlaw to discuss whether an ILIT is the right option for you.


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