An Irrevocable Life Insurance Trust (known as an "ILIT") is one of the most powerful estate planning tools in the world, second only to the Revocable Living Trust. An ILIT is a special type of Trust designed to own life insurance policies and to protect the proceeds from estate taxation.
The proceeds of life insurance policies can mean cash available to your loved ones when they need it most. That same cash also faces federal estate tax beginning at 37% and running as high as 55%. Life Insurance proceeds are exempt from income tax, but they are subject to estate tax.
If your estate will be subject to estate tax, life insurance proceeds can help pay that tax. Having life insurance in your estate provides a nice nest egg of cash, but it is taxable cash. The very life insurance you buy to help pay estate taxes is itself taxed. The more life insurance you have, the more tax you pay. The situation is a two-edged sword that the tax man is delighted to use to slice up your assets.
A Better Way
There is a better way to structure your affairs. It is possible to have the benefits of life insurance and to avoid punitive estate taxes on the life insurance proceeds. That better way is the Irrevocable Life Insurance Trust.
An ILIT is a Trust that is separate from your primary estate plan. It is irrevocable, meaning you cannot change it once you have created it. It works something like this:
First Steps
First, you meet with your financial advisor, your estate planning advisor or an attorney knowledgeable in Trust planning matters to discuss what benefits an ILIT might offer you.
Second, if you decide that an ILIT is for you, then you meet with your estate planning advisor to get the process under way. The Trust creation process includes selecting a Trustee and beneficiaries. You might use your life insurance agent or your accountant as the independent Trustee. Your attorney creates the Trust documents to reflect your decisions and plans.
Third, you sign the Trust document and thus create the Trust. The Trust is a separate legal being that contains two important things: your instructions for what you want done with the property (life insurance and cash) in the Trust and a delegation of authority to the Trustee and the successor Trustee or Trustees to carry out your instructions.
Fourth, you give some money to the Trustee, on behalf of the beneficiaries. The Trustee deposits the money in the Trust checking account. The money given to the Trustee is exempt from federal gift and estate taxes up to the annual exclusion amount (currently $10,000 per beneficiary per year) and is treated as a gift to each beneficiary.
The Annual Exclusion
To qualify the gift for the annual exclusion, the beneficiaries must have the right to withdraw the gift each year. The Trustee must give all beneficiaries notice of the gift and of their rights to withdraw it. If the beneficiaries do not withdraw the gift, the Trustee uses the first gift to purchase life insurance on the Trustmaker, and gifts in subsequent years to pay the annual premiums.
This cycle of gifts, notices and premium payments continues each year. When the insured dies, the Trustee collects the insurance proceeds. If all the requirements of annual contributions, notices, etc., have been met, those proceeds will not be part of the taxable estate of the insured Trustmaker.
The Final Payoff
The language in the Trust gives the Trustee authority to use the funds (the life insurance proceeds) in the ILIT to purchase assets (like stock, or the residence, or farmland) from the Trustee or the executor in the primary estate or to distribute the funds to the named beneficiaries following the Trustmaker's instructions.
The ILIT and the procedures required to make it effective may seem a little complicated. The procedures are designed to meet specific requirements of the Revenue Code and of IRS rulings and court decisions interpreting and applying the Code. Once the Trust and the insurance are put into effect, however, the operation of the Trust is a very simple matter. An ILIT is certainly a better alternative than paying 37% to 55% of life insurance proceeds to the government in estate taxes.
Because the technical language required for an ILIT, is designed to meet the strict requirements of the Revenue Code, it is important to obtain advice and services from professionals who have knowledge, skills and experience with life insurance Trusts.
Timing
You can create an ILIT only while you are competent and while you either have existing life insurance or are able to qualify for new life insurance. When either of those windows of opportunity closes in your life, your ability to create an ILIT and to reap its substantial benefits is gone in an instant.
As with any type of estate planning, don't delay. To learn more about ways you might claim these benefits of life insurance planning for yourself, your loved ones and your favorite charities, please call Dr. Don Lassiter, Assistant to the President and Director of Planned Giving at (336) 272-7102, extension 223, or E-mail him at dlassiter@gborocollege.edu.
This discussion of estate planning and life insurance concepts is not legal, tax or financial advice and is provided for educational purposes only. Legal, tax or financial questions should be directed to your professional advisors for discussion in context with your personal situation.
Office of Planned Giving
Greensboro College
815 West Market Street
Greensboro, North Carolina 27401-1875
336-272-7102, extension 223
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