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Is an Irrevocable Life Insurance Trust Right for My Estate Plan?

An irrevocable life insurance trust (ILIT) is a type of trust someone creates during their lifetime. The trust owns and controls a permanent or term life insurance policy for another person’s benefit. It can also manage and distribute proceeds according to the insured’s wishes when they die.

An ILIT can be a valuable tool in estate planning. You should consider the advantages and disadvantages before creating one. Below are the most common benefits of an ILIT.

Reduce Estate Taxes

Your gross estate will include the death benefit of the life insurance policy if you are the owner and insured. If the ILIT owns the life insurance, it isn’t part of your estate. That means the proceeds are not subject to federal and state taxes when you die.

A properly drafted ILIT can provide liquidity to pay debts, estate taxes, and other expenses by purchasing assets through a loan or from the estate. Lifetime gifts will also minimize your taxable estate if you transfer assets into your ILIT while alive.

Avoid Gift Taxes

You might be able to avoid gift tax consequences by adding an ILIT to your estate plan and setting it up correctly. Contributions you make to your beneficiaries are gifts. Avoiding taxes requires the trustee to inform the beneficiaries of their right to withdraw a share of the proceeds from the trust during a 30-day timeframe.

Once the 30 days pass, the trustee can use the remaining contributions to pay the premium for the insurance policy. Taking the necessary steps qualifies the beneficiaries’ transfers for an annual gift tax exclusion. It makes those transfers a gift instead of future interest.

Government Benefits

If one of your trust beneficiaries receives government aid such as Medicaid or Social Security disability income, having an ILIT own your life insurance policy protects their future interests. The trustee can manage the distributions to these beneficiaries for specific purposes so they don’t affect the beneficiary’s eligibility for government benefits.

Asset Protection

An ILIT protects the life insurance proceeds from creditors and legal judgments since the trust owns the policy. That means your beneficiaries don’t have to worry about a collections agency taking the proceeds to satisfy your debt after you die.

Control Over Distributions

You give your chosen trustee authorization to manage the ILIT after your death. They can use their discretion to determine when and how to distribute proceeds or follow the instructions you leave them.

You can decide on an immediate payout to your beneficiaries or smaller amounts for a specific period. You might want your loved ones to receive distributions after reaching milestones such as getting married or buying a house.

The choice is yours, and your trustee must fulfill your wishes. If you give them control to decide how to handle the ILIT, they might transfer funds like a paycheck to cover the beneficiary’s monthly expenses or provide a payout to pay medical bills.

Tax Benefits

A separate tax identification number and aggressive income tax schedule apply to irrevocable trusts. However, the cash value of a death benefit that accumulates in a life insurance policy is free from taxation.

When set up correctly, the trustee can access the policy’s cash value by taking distributions or loans on a cost basis. That can happen even while you’re still alive. The only exception is when you die. If proceeds remain in the trust after paying the death benefit, investment income earned that doesn’t get distributed to the beneficiaries could be subject to taxation.

Protect Your Loved Ones with an Estate Plan

You want to care for your family long after you’re gone. An irrevocable life insurance trust might be what you need to give your loved ones financial security.

The legal team from Jeffrey M. Rosenblum, P.C. has fulfilled our clients’ estate planning needs for over 40 years. Call us at 866-637-7300 for a free initial consultation with an Armonk estate planning attorney to learn more about how an ILIT could benefit your estate.

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