Do You Need an Irrevocable Life Insurance Trust? – In most cases, when people decide it’s time to invest in life insurance, they either go through their employers or purchase a policy directly from an insurance company. However, families can also purchase a policy inside an irrevocable life insurance trust to exempt the proceeds from the estate tax. When you create an ILIT to buy life insurance policies for you and your loved ones, you don’t legally own the policies, the trust does. That means that upon your death, the insurance proceeds go into the trust and aren’t subject to probate, income taxes or estate taxes.
Another advantage of the trust is that it can cover the cost of raising a child in the event of your death. It can be set up to hold the money for minor children. Instead of naming your kids as beneficiaries of your life insurance policy, you would name the trust and trustee. Upon your death, the trustee would manage and spend the money according to the rules you set for the trust, supervising the money until your kids reach legal adulthood.
You could arrange for the trust to pay for your children’s upkeep and college educations and then distribute portions of the remaining money to your children at specified times, such as their 25th and 30th birthdays.
ILITs can provide immediate liquidity to beneficiaries tax free; the value of the trust is outside the estate and not subject to taxable estate calculation. But beneficiaries need to understand the purpose of the ILIT so they don’t inadvertently run afoul of any rules. If money is withdrawn before the trust pays all the premiums, the policy could lapse, causing the trust to dissolve.
You need to be committed to keeping the policy over a long period — the costs associated with a permanent life insurance policy tend to rise over time. To keep the policy from lapsing, you need to be able to fund the policy.
Grantors can also use ILITs to protect money from their children’s creditors and from spouses in the event of a divorce. If the grantor owns a business, an ILIT can provide a quick payout if there’s a buy-sell agreement in place.
Know the fine print
Once the life insurance policy is placed in the trust, it’s managed by the trustee on behalf of the beneficiaries. You can’t change or designate a beneficiary or increase or decrease the policy. You should also know that if you die within three years of transferring your life insurance policy to your insurance trust, the IRS will still include the proceeds in your estate for estate tax purposes. Keeping up with premiums will help.
This is just an introduction to a complex topic. ILITs can solve many problems but are not right for everyone; sometimes another kind of trust is best. Be sure to contact legal and financial professionals to assemble an estate-planning tool kit that’s right for you.
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