Using an Irrevocable Life Insurance Trust to Avoid Estate Taxes
Establishing an irrevocable life insurance trust is a way to avoid paying taxes on life insurance proceeds. Ownership of insurance policies are transferred to the trust and proceeds are exempt from estate taxation.
The irrevocable life insurance trust includes a contract which is used to distribute proceeds to designated beneficiaries. The trust itself is designated as the primary beneficiary. Upon death, proceeds are transferred into the trust and held to provide benefits to a spouse, children, or other beneficiaries.
There are three parties involved with irrevocable life insurance trusts (ILIT). The ‘Insured’ is the person who takes out the policy. The ‘Trustee’ is the administrator of the ILIT and ‘Beneficiaries’ are the individuals who receive insurance proceeds.
After setting up the trust the insurance policy is placed inside the trust and cannot be changed. Policy holders retain control over beneficiary designation and how insurance proceeds will be distributed.
Distribution can occur as an immediate payout upon death or distributed monthly, quarterly, semi-annually, or annually. Proceeds can also be distributed when beneficiaries reach specific milestones such as getting married, buying a first home, starting a business, or graduating from college.
Irrevocable life insurance trusts (ILIT) also allow policy holders the option to establish distribution schedules if designated beneficiaries require funds for a specific purpose. These could include capitalizing on an investment opportunity, starting a new business, or expanding a business.
ILITs can be a good option when beneficiaries receive government assistance funds such as social security disability, Medicare or Medicaid. Distribution of insurance proceeds can be controlled so they do not interfere with the beneficiary’s capped wage earnings.
ILITs also provide the policy holder’s heirs with several tax advantages. The primary advantage is the annual gift tax exclusion. Using an irrevocable life insurance trust, policy holders are allowed to gift up to $11,000 tax-free annually to designated beneficiaries. Spouses can elect to “gift split” which means the annual gift tax exclusion could be doubled.
Irrevocable life insurance trusts can be expanded by entering into a Generation Skipping Trust. Generation skipping is designed to eliminate estate taxes for future generations such as grandchildren and great-grandchildren. This type of trust is also referred to as a Dynasty Trust.
Establishing an ILIT is a complex process that requires the services of an estate planning attorney. This type of trust requires specific documentation including obtaining a taxpayer identification number and submitting demand right notification to beneficiaries. Few people can comply with IRS guidelines and documentation requirements without legal assistance.
ILITs can be a very powerful tool when establishing estate planning protocol. However, the trust must be properly documented and abide by specific guidelines. Careful consideration must be given to who will administer the trust, designation of beneficiaries, and distribution schedules because once the irrevocable life insurance trust is executed, terms cannot be changed.
Simon Volkov is a probate liquidator and real estate investor who specializes in buying probate properties. He shares insights on estate planning and offers tips for incorporating strategies to avoid probate, how to establish an irrevocable life insurance trust, and which strategies to incorporate to eliminate estate taxes. Discover powerful estate planning tools at www.SimonVolkov.com.
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