irrevocable life insurance trust
An Irrevocable Life Insurance Trust (ILIT) is a special trust designed to own and control a life insurance policy, providing tax benefits and asset protection. Once you create and fund the trust, you cannot make changes (hence "irrevocable"). The main purpose of an ILIT is to prevent the life insurance policy proceeds from being counted as part of your estate, which can reduce estate taxes and protect your beneficiaries.
How an ILIT Works:
Create the Trust: You work with a lawyer to establish the trust.
Fund the Trust: You transfer ownership of your life insurance policy to the trust. This means the trust, not you, owns the policy.
Appoint a Trustee: The trustee (often a family member or financial institution) manages the trust and is responsible for paying the policy premiums.
Payout: When you pass away, the life insurance proceeds go into the trust and are distributed to your beneficiaries according to the rules you’ve set, all without being taxed as part of your estate.
Example:
Imagine you have a life insurance policy worth $1 million. If you pass away and the policy is part of your estate, the value of your estate (including other assets) might push you above the federal estate tax exemption limit. This could result in a large portion of your estate being taxed.
By placing the policy in an ILIT, the $1 million life insurance payout bypasses your estate and goes directly to your heirs tax-free. The ILIT protects that money from estate taxes and ensures that your beneficiaries receive the full amount.
Benefits:
Estate Tax Savings: Since the life insurance policy is not part of your estate, it can reduce or avoid estate taxes.
Asset Protection: Protects the policy proceeds from creditors or legal claims.
Controlled Distribution: You can specify how and when your beneficiaries receive the money (e.g., lump sum, installments, or under certain conditions).
Limitations:
Irrevocability: Once you place the policy in the trust, you lose control over it. You can’t change beneficiaries or access the cash value.
Complex Setup: Requires legal and financial expertise to set up properly, so it may involve legal fees.
In summary, an ILIT is a powerful tool for those with large estates who want to minimize taxes and protect assets for their beneficiaries. It provides both tax benefits and a way to control how life insurance proceeds are used.