Creating an estate plan can be as easy as 1-2-3 or as complex as the science to send a man to the moon.
It all depends on the assets you have, what you are trying to protect, and what it is you want to accomplish. Irrevocable Life Insurance Trusts (ILIT’s for short) are a common tool used by individuals to shelter their estate from paying high estate taxes, and to protect the interest of their beneficiaries. However, even though they are common, oftentimes, individuals do not know where, when, or how to add an ILIT to their estate plan.
When an individual buys life insurance, usually, they do not understand the unique features that it has compared to other financial products in the market. Specifically, how it can save them from taxes, create an estate, and provide protection to their beneficiaries from creditors.
Understanding where to use an irrevocable life insurance trust is just as important as understanding why to use it or when to use it. When a person buys life insurance, the death benefit is not generally taxable, but the value is figured into your overall estate. Understanding taxability is important because for high net worth individuals, a life insurance policy could potentially push them over the estate tax exclusion amount. If this happens, then they will have to pay estate tax. The current estate tax exemption is $11. 5 million for individuals, which is about $23 million for married couples. However, with a new presidential election on the horizon, there is a possibility that this amount may be reduced. Thus, creating an irrevocable life insurance trust can shield you from having to pay estate taxes by moving the life insurance policy out of your estate.
There are two types of trusts; irrevocable and revocable. An irrevocable trust cannot be altered or changed, but a revocable trust can be changed at any time. Once an irrevocable life insurance trust is created; the life insurance policy is now separated from the estate which saves you from the tax burden. Other advantages of irrevocable life insurance trusts are the owner is given more control over the distributions to beneficiaries. When a grantor creates an irrevocable life insurance trust they can outline to the trustee specific directions as to when and how they want the assets distributed. The grantor now has the ability to control the life insurance proceeds even after he/she passes. Why is this important? As the grantor, you can decide if you want the life insurance proceeds to offer support for beneficiaries or to enable the beneficiaries. Basically, are you wanting to give them a fish or do you want to teach them how to fish. For grantors who want to prevent the “trust fund baby” an irrevocable life insurance trust gives them the structure in order to do so.
A beneficiary of irrevocable life insurance trust will also have control depending on the language outlined in trust document. If a beneficiary is dealing with trustee that is not doing a great job, there are options for them to make a change. However, this depends on the state and the language inside the trust document.
Now that we have discussed both where and when an ILIT make sense, we have to discuss how an irrevocable life insurance trust can be created. In short, there are three big steps that a grantor must take when they are creating an ILIT. First, selecting which type of life insurance you want. There are two types of life insurance, permanent life insurance and term life insurance. Second, you must consult an attorney. The attorney will be responsible for drafting the trust document, and outlining what it is you would want to have happen. Third, picking a trustee. The trustee you choose is important because they control everything.
Creating a ILIT can be complicated, or it can be simple. The great part is that you get to choose. To learn more about the in’s and out’s check out our definitive guide. In this guide you will learn more about the three important steps you will need to take to create a irrevocable life insurance trust.