Detailed Understanding of Irrevocable Life Insurance Trust

At times individuals aren't aware that the internal revenue service can include proceeds from their life insurance policies in their estates for tax purposes when they die. But there are ways around it.  One of the best options is to have an Irrevocable Life Insurance Trust also widely known as ILIT.

So, what is ILIT?

An irrevocable life insurance trust is a type of irrevocable trust that's specifically designed to set up to own a life insurance policy. You can transfer ownership of an existing policy to the ILIT after it's been formed, or the trust can purchase the policy directly.

You can't serve as trustee of the trust for 2 reasons. First, the trust must be irrevocable, which means that you must fund it and step aside. You abandon any rights to make changes to it or to dissolve it.

And second, acting as trustee will give you something called "incidents of ownership" because you would preserve the control over the policy. But your spouse, your adult children, a friend or even a financial institution or an attorney can serve as trustee for you.

Who can be the beneficiaries of ILIT?

An irrevocable life insurance trust is normally selected as the insurance policy's primary beneficiary. Death benefits are deposited into the ILIT when you die and they're held in trust for the benefit of the beneficiaries you have named in your trust documents to receive them.

If the proceeds are held in trust for the benefit of your spouse instead of going directly to her, she will receive regular incremental payments rather than the lump sum of proceeds, so they can't be taxed as part of her estate.

Complications of ILIT

If you die within 3 years of transferring your life insurance policy to your ILIT, the IRS will still include the proceeds in your estate for estate tax purposes. You can avoid this by having the trust purchase the policy on your life, then funding the trust with sufficient money over the years to pay the premiums.

You normally can’t undo an Irrevocable Life Insurance Trust after you have set it up. But; because of the ongoing premiums must be paid to keep the life insurance policy in effect, all you'd have to do if you wanted to cancel the trust is stop making payments for the premiums. The trust would automatically become empty; when the policy lapses.