IRREVOCABLE LIFE INSURANCE TRUST (ILIT) – The Basics

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  An Irrevocable Life Insurance Trust (ILIT) is an advanced estate planning strategy used to shelter a life insurance policy from estate tax. While life insurance proceeds are not subject to income tax, the value of a life insurance policy is included in the policy owner’s taxable estate. This can have significant estate tax consequences if the value of the grantor’s estate is above or even near the applicable federal or state estate tax threshold. Some states begin to impose estate tax at thresholds as low as a few million dollars. Thus, a life insurance policy can create an estate tax issue when combined with other common assets such as a primary residence, brokerage accounts, and an IRA.

An ILIT can be combined with a new life insurance policy that is purchased in conjunction with the formation of the ILIT, or an existing policy can be transferred into the ILIT. Typically, the grantor then makes annual contributions into the ILIT to pay the premiums. Additional planning – so called “Crummey letters” – are also required to ensure that these additional contributions to the ILIT will qualify for the annual gift tax exclusion.

•  Minimize Estate Tax: Life insurance is a necessary part of many financial plans. However, life insurance can also cause unforeseen estate tax issues because many individuals and even their planners often do not realize that life insurance is included in the policy owner’s gross estate for estate tax purposes. If life insurance is part of your estate plan, an ILIT may be appropriate to keep the value of the policy out of your taxable estate while still ensuring that the financial benefit of the insurance still goes to your intended beneficiaries.
• Create a Multigenerational Trust: An ILIT can be structured to hold assets in trust for future beneficiaries including children, grandchildren, and other individuals. The grantor has considerable flexibility in specifying how the assets are to be managed and used, and may impose restrictions and guidelines on the beneficiaries’ access to the trust funds. This type of long-term planning is not available in a scenario where a life insurance policy simply names beneficiaries directly. In that case, the death benefit would be paid outright to those beneficiaries with no additional parameters or oversight as to how the assets are to be used.
• Additional Gifts into the Trust: Once an ILIT has purchased a new policy, or an existing policy has been transferred, ongoing annual premiums generally need to be paid. In most cases, the grantor will make annual contributions to the ILIT in an amount equal to the premium, or in some cases a greater amount. If properly structured, these contributions will qualify for the annual gift tax exclusion. In order to qualify as annual exclusion gifts, the trustee of the ILIT must send letters each year (often called “Crummey” letters) to the beneficiaries informing them that a contribution has been made to the trust and notifying them of their right to withdraw their portion of the gift within a specified period of time. It is generally advantageous that the beneficiaries do not exercise this withdrawal right, but the right must exist and they must be notified of it.

•  Work with an Attorney to Create the Trust: An ILIT must be carefully drafted in order to keep the policy and any other trust assets out of the grantor’s taxable estate, while at the same time ensuring that the grantor’s additional contributions qualify for the annual gift tax exclusion. Additionally, a trustee must be selected to manage the trust, send Crummey letters each year, and manage the trust for the benefit of the beneficiaries after the grantor’s death.
• Select the Policy: The grantor will work with their insurance advisors to select the appropriate type of life insurance policy for their needs. This may be single life, second to die, term, whole, or any other type of policy that is appropriate. 
• Put the Policy In-Force and Pay Premiums: Once the policy is selected and the ILIT is created, the ILIT will own the policy. The trustee will manage the trust, send the annual Crummey letters to beneficiaries, and ensure that the policy premiums are paid each year. The grantor will make additional contributions to the trust sufficient to pay the annual premium. The trustee will also manage the trust for the beneficiaries’ after the grantor’s death.