What Is a Life Insurance Trust?

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With the help of a life insurance trust, you can potentially reduce estate taxes and ensure that the death benefit is used according to your wishes. A life insurance trust is a type of trust that owns a life insurance policy. Basically, you—the insured person—are the trust’s grantor. The trust is the owner of the life insurance policy. When you pass, the life insurance proceeds are paid to the trust. 

This type of trust is irrevocable, meaning you can’t dissolve it once it’s set up. However, even with this limitation, there are some advantages to using an irrevocable life insurance trust (ILIT) as part of a long-term estate planning tool, especially if you’re wealthy.

Benefits

Many of the benefits associated with an ILIT depend on its structure and the terms of the trust upon its creation. As a result, before establishing a trust, it’s important to consult with a knowledgeable estate planning attorney or another professional. 

Some of the potential benefits of a life insurance trust include: 

  • The death benefit of the life insurance policy isn’t part of the value of your estate. 
  • Use what’s known as a Crummey Letter to avoid having the life insurance premiums considered gifts. 
  • Guidelines for how the money in the trust—including the life insurance policy proceeds—can be used by beneficiaries, ensuring your legacy is honored. 
  • Creditors and the IRS can’t access the assets held in this trust. 

Drawbacks

Before you decide to use this type of trust, it’s important to pay attention to some of the disadvantages. Here are a few things to consider before you move forward with an ILIT. 

  • Creating an ILIT can be time-consuming and expensive, so it might be less effective if you don’t meet the estate tax threshold. 
  • Beneficiaries could end up with a bigger tax bill later since proceeds could be considered part of their estates. 
  • You can’t change an irrevocable trust later, so you’re stuck with it. 
  • Depending on the situation, you might need to pay fees to trustees or managers. 

It is possible to terminate the trust if you fail to pay your premiums, and there are other approaches you can take, but for the most part, it’s a good idea to make sure you have everything as you want it before opening an ILIT. 

How to Open an ILIT

If you decide an ILIT is right for you, open the trust before purchasing the life insurance policy. Talk to a knowledgeable estate or tax attorney who can help you move forward with the right steps: 

  1. Establish the trust as an irrevocable trust. The person establishing the trust is known as the grantor. 
  2. Transfer assets into the trust to be used for premium payments. 
  3. Ensure trustees follow the requirements associated with a Crummey Letter when gifts are transferred to ensure that they aren’t subject to gift tax limits. 
  4. Once everything is set up, the trust can then apply for a life insurance policy. The policy will cover you, the grantor, but the owner and beneficiary of the insurance policy with be the trust. 

Bottom Line 

A life insurance trust can be a powerful estate planning tool for securing your legacy and potentially reducing taxes. However, before you decide to make this move, make sure you understand the requirements of an ILIT, and make sure that your estate is large enough to warrant using this strategy. 

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