An irrevocable life insurance trust (ILIT) is a valuable estate planning tool. With it, you can create a legacy that bypasses probate, reduce your estate taxes, pay final costs, and guide the use of its funds for years beyond your death. But take precautions to make sure your ILIT performs the tasks you set for it. Here are some to consider.
The Irrevocable Character
Your ILIT is irrevocable if you can't actively control or change the operation of the trust or its contents after it's been formed (executed). As a trust it bypasses your probate process, but its irrevocable character makes it a separate entity from you for estate tax purposes too.
Funding the ILIT
The idea of the ILIT is that its value at the time of your (as the insured) death includes all proceeds of any life insurance owned by the trust. It acquires a policy either by you gifting one that you own, or having your revocable life insurance trust purchase a new policy on you.
- If you gift your life insurance policy, you need to pay gift tax on its current value. However, if you die within 3 years of transferring it to the ILIT, the insurance proceeds will be added to your gross estate for estate tax purposes.
- If the ILIT - after being formed - purchases as life insurance policy on you, the 3-year rule doesn't apply. You can pay the premiums to fund the life insurance trust's life insurance policy by gifting the premium amounts each year. However, you'll need to include a Crummey Provision in the trust's documents making them gifts of present value to qualify for the annual gift tax exclusion ($12,000 in 2008),
Choice of Life Insurance
If the life insurance trust is to purchase the life insurance policy, you'll have to write in one best-suited to your situation. If you're a married couple you may choose a "survivorship policy" that pays a death benefit at the second to die.
Irrevocable Life Insurance Trust Document Instructions
Your ILIT must be customized to what you want to achieve with it - i.e. who gets what when! You'll need to write specific instructions for the trustee to follow on how the life insurance proceeds will be managed after the grantor's death and whether the trustee can exercise discretion.
Will he distribute some for final expenses, some right away for a beneficiary, but hold and manage the remainder for a grand child's education? All these considerations require careful thought and drafting to not run afoul of your goals.