Do I Need a Life Insurance Trust?

Irrevocable Life Insurance Trusts have three components: a grantor, the person who creates a trust, a trustee, the manager of the trust and a beneficiary or beneficiaries, explains a recent article titled “What is an Irrevocable Life Insurance Trust?” from The Edwardsville Intelligencer.

In an ILIT, the trustee purchases the policy, and the irrevocable trust becomes the owner. When insurance benefits are paid on the death of the grantor, the trustee collects the funds, pays any estate taxes due and any outstanding debts, like legal fees and probate costs, then distributes the rest to beneficiaries.

The biggest reason for people to consider an ILIT is to help lessen estate taxes. In the last few years, the federal estate and gift tax exemption has been set at historically high levels, and most people don’t need to worry about that on a federal level. However, state estate taxes still need to be addressed, and the federal estate tax level is set to drop dramatically in 2026.

There are other reasons for an ILIT:

If a life insurance beneficiary is incapacitated, the ILIT can prevent the court system from controlling proceeds.

Proceeds from the ILIT can provide cash to pay expenses, including estate taxes and any other debts.

The ILIT can provide income for the spouse without the funds being included in the spouse’s estate.

The ILIT can provide protection for heirs. Depending upon the state where you live, proceeds from life insurance payouts may or may not have protection from creditors. Speak with your estate planning attorney to learn if this applies to you.

Ability to include a “Spendthrift Provision.” If an heir or heirs has trouble managing money or is prone to making bad decisions, financial and otherwise, the ILIT trust can contain a spendthrift provision to pay beneficiaries monthly, instead of providing them with a lump-sum payout.

However, the ILIT isn’t for everyone. There are some downsides to consider.

The ILIT is irrevocable, and is difficult, if not impossible, to make changes to it, with the exception of changing the trustee. Once a policy is placed in an ILIT, you give up any rights to the policy. You can’t reassign it to a different trust or any other legal entity.

ILITs are complex and nuanced legal vehicles requiring the help of an estate planning attorney who knows their way around trusts. This has been a very general overview of a topic with many moving parts to it. Discuss whether an ILIT will be useful for your estate plan with an experienced estate planning attorney.

Reference: The Edwardsville Intelligencer (Jan. 31, 2023) “What is an Irrevocable Life Insurance Trust?”