Irrevocable Life Insurance Trust

An Irrevocable Life Insurance Trust (ILIT) is a common type of Irrevocable Living Trust.

The ILIT dramatically leverages an irrevocable living trust to save estate taxes on life insurance proceeds.

As the life insurance industry constantly reminds us – life insurance proceeds are not subject to income tax. So, if you designate your son or daughter as the beneficiary of your life insurance policy, they will not have to pay tax on the payout they receive, after you pass away.


But, that's only half of the story.

What about estate tax?

That's what the life insurance industry does not always make as clear. The value of a life insurance policy IS included in the policy owner's estate and, thus, potentially subject to estate tax.

So, if you buy a $5,000,000 policy for your children. That $5,000,000 payout will be included in your estate and subject to estate tax. And, as discussed at Estate Tax, estate taxes can be atrocious.

So, what can you do to avoid having your estate pay estate tax on your life insurance policy?

The answer is simple: get the life insurance out of your estate!

Probably the best way to do that is through use of an Irrevocable Life Insurance Trust.

Here's how it most commonly works :

  1. Create an Irrevocable Life Insurance Trust (ILIT), designating who the beneficiaries will be and how much each is to receive.

  2. Gift money to the trust to fund the purchase (by the trust) of the life insurance policy on your life.

  3. ILIT trustee (should be independent of trust creator) purchases the life insurance policy with the money you gave to the trust.

  4. Continue to gift money to the ILIT to pay the premiums as they are due.

  5. At your death, the life insurance proceeds are paid to the ILIT and distributed according to the terms of the trust.

Save tax

As long as you have no "incidents of ownership" in the Irrevocable Life Insurance Trust, the life insurance proceeds will not be considered part of your estate. Obviously, the money you transfer to the trust to pay the life insurance premiums will also not be part of your estate. So, it can all add up to significant estate tax savings.

[See Irrevocable Living Trust for more information about incidents of ownership. There are also other ways to use an ILIT to obtain other advantages, even to benefit the grantor or his or her spouse. These other methods are beyond the scope of this page.]

The tricky part is that the gifts you give to the ILIT (to fund the premium payments) could be subject to gift tax. However, you have an annual $12,000 gift tax exclusion that allows you to give anyone a gift valued up to $12,000 every year. For most people, $12,000 could cover the premiums for a very nice life insurance policy.

Then, let's say you combine your spouse's $12,000 annual gift tax exclusion – and (if you have say 4 kids) you could have all of them share in the life insurance proceeds. So now you can spend $12,000 X 2 X 4 = $96,000 a year for life insurance premiums.

You can buy a tremendous life insurance policy with that kind of premium payment. As life expectancies continue to lengthen, life insurance gets cheaper and cheaper.

And by using an Irrevocable Life Insurance Trust, you can avoid income, gift, and estate taxes on the premiums and the ultimate distribution.

So, the Irrevocable Life Insurance Trust is quite a powerful estate planning tool.

BUT, for this to work, there is an additional complicating factor to consider. It is discussed at Crummey Trust .

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