An irrevocable life insurance trust (ILIT) can provide peace of mind as you start your estate planning process. If you have a sizable estate or young beneficiaries, an ILIT can provide control over a life insurance policy that a last will and testament may not. The “irrevocable” part of that trust means that its creator, or grantor, can’t amend it once it’s set up. Such a trust has its benefits, but there are variable to consider before setting it in stone. A financial advisor can help with all your trust needs and more. Consider finding one with SmartAsset’s free financial advisor matching service.
A revocable trust allows the grantor to make changes or even end the trust if they want to. An irrevocable trust doesn’t allow any changes from the trust creator once it’s been set up. The only people who are allowed to make and approve changes are the beneficiaries.
Revocable trusts tend to be more common since there’s more flexibility for the trust creator to make changes to the policy. But irrevocable life insurance trusts may still be a good idea if you need one.
A grantor sets up and funds the trust while alive. If there are any gifts or transfers made to the trust, they’re permanent and can’t be changed. The trustee — who is different than the grantor — manages the trust and handles how distributions to beneficiaries are made.
As mentioned earlier, irrevocable trusts have some benefits despite their inflexibility.
With an irrevocable trust, deaths benefit are not part of your gross estate. That means they aren’t subject to state and federal estate tax. Such a trust can also help cover estate tax costs and other debts as long as the estate makes the purchases, not the grantor. Because the estate is now part of the trust, you’re no longer on the hook for estate taxes.
It’s important to note that while your estate is exempt from estate taxes, they are subjected to your beneficiaries’ estate. That can shift your high tax burden onto them.
Minors might not be responsible or equipped to handling assets, especially large amounts of money.
An irrevocable allows restrictions to be put in place. You can set it up so beneficiaries have to reach a certain age to gain assets or accounts.
If you think you’re liable for certain legal proceedings, an irrevocable trust can protect you and your family from them.
Having a high-liability business that can face claims regardless of you living or dying can add stress to your family. With an irrevocable trust, your assets are protected from creditors.
The IRS notes that life insurance payouts are typically not included among your gross assets. You usually don’t have to report them, but there are exceptions.
If you’ve earned interest on a life insurance payout, any interest you have received is taxable. Also, if a life insurance policy was transferred to you by another person for a sum of money, only the sum you paid is excluded from taxes.
Though the estate tax exemption for 2019 is $11.4 million, an estate of that size could be pushed over the limit by a life insurance payout. State estate tax exemptions also tend to be lower than that amount. By using an ILIT, a grantor can exclude a life insurance payout from the gross estate.
An ILIT would also shield a life insurance payout and your beneficiaries from any legal action against you. Legally, ILITs are not owned by the beneficiaries, which makes them tough for the courts to label as assets. It also makes it almost impossible for creditors to take those funds.
Finally, as mentioned earlier, an ILIT can prevent a life insurance payout from going directly into the hands of a minor. The ILIT can direct those funds to a spouse or to a trustee. That person can be directed to hold onto those funds until a minor reaches adulthood or meets benchmarks you’ve specified.
An ILIT has some quirks that may be frustrating during the estate planning process
Some of the tax benefits of an ILIT only kick in if you live three or more years after transferring your life insurance policy to the trust. Otherwise, the IRS will include life insurance proceeds in your estate for estate tax purposes.
The ILIT can purchase the policy and avoid that three-year stipulation. But you’ll have to fund the trust to pay premiums.
Giving the trust money for that policy may make you subject to gift taxes. However, if you send beneficiaries a letter after each transfer notifying them they don’t have immediate access to the money, gift taxes won’t come into play.
The most glaring downside to an ILIT is that you can’t change it once it’s established. You relinquish control of assets and can’t dissolve the trust unless you simply stop making payment for premiums. Finally, while the trust absolves you of certain tax implication, your beneficiaries may take on a sizable tax burden once they receive your estate.
An ILIT is a good idea if you have a significant amount of wealth and assets you need to protect after you pass. To avoid hefty estate tax and creditors, as well as set up your family after you pass, an ILIT might work for you.
But they aren’t for everyone. You give up the right to make any changes to the policy once it’s set up. Only the beneficiaries of the trust are allowed to approve changes. If you’d like more control over your afterlife plans, you may want to consider a revocable trust or other legal means instead.
Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/designer491, ©iStock.com/monkeybusinessimages
Dori ZinnDori Zinn has been covering personal finance for nearly a decade. Her writing has appeared in Wirecutter, Quartz, Bankrate, Credit Karma, Huffington Post and other publications. She previously worked as a staff writer at Student Loan Hero. Zinn is a past president of the Florida chapter of the Society of Professional Journalists and won the national organization's "Chapter of the Year" award two years in a row while she was head of the chapter. She graduated with a bachelor's degree from Florida Atlantic University and currently lives in South Florida.
Read More About Estate Planning
More from SmartAsset
SmartAsset Advisors, LLC ("SmartAsset"), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. Securities and Exchange Commission as an investment adviser. SmartAsset's services are limited to referring users to third party advisers registered or chartered as fiduciaries ("Adviser(s)") with a regulatory body in the United States that have elected to participate in our matching platform based on information gathered from users through our online questionnaire. SmartAsset receives compensation from Advisers for our services. SmartAsset does not review the ongoing performance of any Adviser, participate in the management of any user's account by an Adviser or provide advice regarding specific investments.
We do not manage client funds or hold custody of assets, we help users connect with relevant financial advisors.
This is not an offer to buy or sell any security or interest. All investing involves risk, including loss of principal. Working with an adviser may come with potential downsides such as payment of fees (which will reduce returns). There are no guarantees that working with an adviser will yield positive returns. The existence of a fiduciary duty does not prevent the rise of potential conflicts of interest.
