Life insurance can afford you the peace of mind that if you pass away your loved ones will be provided for in your absence. The downside, however, is that inherited life insurance proceeds can be subject to estate taxes. This means that federal and state taxes, depending on where you live and the value of your estate, can reduce the amount of benefits to your beneficiaries by as much as 45 percent.
None of us want our legacy depleted in any way. This is one of the reasons why an Irrevocable Life Insurance Trust provides a solution. An Irrevocable Life Insurance Trust, also known as an ILIT, is a trust that avoids estate taxes by placing life insurance proceeds in the trust at the time of your death instead of being directly distributed to your designated beneficiaries. In essence, the ILIT is the beneficiary and your heirs are the beneficiaries of the trust.
Let us provide more insight into how it works through your estate planning. If established properly, the ILIT can be a separate entity from the rest of your estate. Accordingly, you will never actually own the life insurance policy or the death benefits, the trust will.
Since the property that you legally own at the time of your death will be subjected to estate taxation, your life insurance proceeds are exempt because the policy was never part of your estate. The catch, however, is that the trust is irrevocable. Once it is created, it cannot be rescinded, amended, or modified. Signing the dotted-line is an acknowledgment that the terms of the trust cannot be changed and that polices and property held in trust cannot be reclaimed. This is something that you will want to discuss with your estate planning attorney as even though there are significant advantages, there can be disadvantages to prepare and plan for.
In addition to favorable tax treatment, other benefits can include, but not be limited to, asset protection and control over how life insurance death benefits are used. A key aspect of an ILIT is selecting a trustee to oversee the distribution of the trust assets. Choose wisely, as the trustee will be tasked with managing the ILIT and distributing funds to your named beneficiaries or cover debts and expenses according to your wishes. If you are unsure whether a family member is best suited, discuss with your estate planning attorney whether or not a professional trustee should fulfill the role.
We know this article may raise more questions than it answers. If you or someone you know would like more information about an Irrevocable Life Insurance Trust and the benefits and protections they offer, we encourage you to contact our law firm now, or at any point in the future.