When someone passes away in Florida, their estate often has to go through a legal…
Understanding Irrevocable Life Insurance Trusts (ILITs)
The federal estate tax exemption allowance seems to be at risk of being reduced, and so it may be a good idea to reevaluate your estate plan.
Senate Democrats are proposing to lower the current estate tax exemption from $11.7 million to $3.5 million for individuals and $23.4 million to $7 million for couples.
No one knows whether this particular Congressional bill will pass into law. However, many expect future changes to estate tax exemptions.
Even without action by Congress, the current rate will sunset in 2026. This change will essentially cut the exemption amount in half to about $6 million per individual.
If you have a larger estate, reviewing your estate plan can help you understand how potential tax changes may affect your assets and beneficiaries.
What Is an Irrevocable Life Insurance Trust?
Many people use an irrevocable life insurance trust as a strategy to address additional inheritance taxation. An ILIT can help reduce estate tax exposure and provide funds to pay some or all of the estate taxes owed by your heirs.
The trust owns one or more life insurance policies. However, you should carefully consider this option before creating an irrevocable life insurance trust (ILIT).
Once you create an ILIT, you generally cannot rescind, modify, or amend the trust. Several important requirements apply when creating and maintaining an ILIT properly.
| ILIT Requirement | Purpose |
|---|---|
| Choose an independent trustee | The grantor cannot control the trust because this may cause the trust assets to become part of the estate. |
| Make the ILIT the policy owner | Trust ownership helps separate the life insurance proceeds from the taxable estate. |
| Use the ILIT bank account for premiums | Proper premium payments help maintain the intended structure of the trust. |
| Follow Crummey notice requirements | Beneficiary withdrawal rights can help qualify transfers for certain gift tax exclusions. |
Requirements for Creating and Maintaining an ILIT
The Grantor Cannot Serve as Trustee
If you create the trust, you cannot also serve as trustee because the trustee controls the trust assets. This control may cause the IRS to consider the trust part of your estate.
You should choose a trusted individual or financial institution to serve as trustee and manage the trust responsibly.
The Trust Must Own the Life Insurance Policy
The ILIT itself must own the life insurance policy.
If you transfer an existing policy to the trust and you die within three years of that transfer, the policy may become part of your estate because of the look-back rule.
The trust can purchase a new policy directly to help avoid this risk.
The ILIT Must Handle Premium Payments Correctly
The trust must pay the policy premiums. You must transfer funds to the trust so the trustee can make those payments.
This process can create gift tax concerns because transfers to a trust do not usually qualify for the annual gift tax exclusion of $15,000.
To qualify for the gift tax exclusion, the beneficiary must receive a “present interest” in the gift.
How Crummey Powers Work
Many ILITs use “Crummey” powers to address this requirement. These powers give beneficiaries the ability to withdraw funds transferred to the trust for up to thirty days.
A Crummey letter notifies ILIT beneficiaries that a gift has been made to the trust. The letter also explains their immediate and unrestricted right to withdraw those assets during the withdrawal period.
After thirty days, the trustee can use the funds to pay the annual insurance premium.
Although beneficiaries technically have the ability to withdraw these funds, explaining the greater future financial benefit often helps prevent this issue.
The Trust Controls Beneficiary Distributions
Generally, the trust becomes the beneficiary of the life insurance policy.
After the insurance company deposits the funds into the trust, the trustee distributes the assets according to the instructions within the trust agreement.
If your beneficiaries are minors, you can instruct the trustee to delay distributions until they reach a specific age.
Keeping assets within the trust may also help protect them from beneficiaries’ creditors.
Benefits and Limitations of an ILIT
ILITs can own both individual and second-to-die life insurance policies. All premium payments should come from a bank account owned by the ILIT.
The main disadvantage of an ILIT is that it remains irrevocable. Once you create the trust, you generally cannot change or cancel it.
However, an ILIT can provide several important estate planning benefits, including:
- Helping minimize estate taxes
- Reducing certain gift tax concerns
- Protecting assets
- Protecting government benefits
- Allowing you to choose when beneficiaries receive distributions
- Providing greater control over how heirs receive life insurance proceeds
Is an Irrevocable Life Insurance Trust Right for You?
An ILIT can be a valuable estate planning tool, but it may not suit every individual or family.
Your financial situation, estate size, beneficiaries, and long-term goals all affect whether an ILIT makes sense for your circumstances.
An estate planning attorney can review your situation and help you determine whether an ILIT fits into your overall trust planning strategy.
Understanding Life Insurance Trusts
Discuss Whether an ILIT May Be Right for Your Estate Plan
If you would like to discuss whether an ILIT may be right for you, give us a call at (352) 565-7737. Conversations are complimentary.
