High-net-worth individuals often seek effective strategies to manage and preserve their estates. One powerful tool is the Irrevocable Life Insurance Trust (ILIT). Understanding how ILITs work and their benefits can significantly enhance estate planning efforts.
How Does an ILIT Work?
An ILIT is designed to own and control a life insurance policy, thereby removing the policy’s value from the insured’s estate. This setup helps reduce estate taxes and ensures that beneficiaries receive the intended benefits in a controlled and tax-efficient manner.
The grantor, or the person creating the trust, establishes the ILIT, which is irrevocable and cannot be altered once created. The grantor then transfers an existing life insurance policy to the ILIT or the ILIT purchases a new policy. By doing this, the policy is removed from the grantor’s estate, potentially reducing estate taxes.
The grantor makes cash gifts to the ILIT, which are used by the trustee to pay the insurance premiums. These gifts can qualify for the annual gift tax exclusion (up to $17,000 per beneficiary as of 2024). Beneficiaries are given “Crummey powers,” allowing them to withdraw the gifted amount for a limited time (usually 30 days), ensuring the gifts qualify for the gift tax exclusion.
Upon the insured’s death, the life insurance proceeds are paid to the ILIT and are not included in the grantor’s estate, thus avoiding estate taxes. The trustee manages and distributes the proceeds according to the trust terms, providing income, paying specific expenses, or distributing the principal at designated milestones.
Types of Life Insurance and Example Scenario
Life insurance policies commonly used in ILITs include term life insurance and permanent life insurance. Term life insurance provides coverage for a specific term (e.g., 10, 20, 30 years) and is often used for temporary needs. Permanent life insurance, which includes whole life, universal life, variable life, and guaranteed universal life insurance, offers lifetime coverage with potential cash value benefits.
Consider a high-net-worth individual who anticipates a significant estate tax liability. They might purchase a $5 million or $10 million whole life or universal life policy through an ILIT. This ensures that upon their death, the estate has sufficient liquidity to cover estate taxes and provide for beneficiaries without forcing the sale of other valuable assets.
Key Benefits and Conclusion
An ILIT offers several key benefits for high-net-worth individuals, including the reduction of estate taxes by removing life insurance proceeds from the grantor’s taxable estate. It provides control over the structured distribution of assets to beneficiaries and shields the death benefit from creditors of both the grantor and beneficiaries. Additionally, it offers liquidity to cover estate taxes and other expenses, ensuring the estate can manage financial obligations without liquidating other valuable assets.
Understanding the mechanics and benefits of ILITs allows for informed decisions to better manage and preserve estates for future generations. For expert guidance tailored to your unique situation, contact Santa Barbara Fiduciary for professional assistance in estate planning.
