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Irrevocable Life Insurance Trusts (ILITs)

Before we get into the nuts and bolts of irrevocable life insurance trusts, we need to first understand the terminology:

Trust: A legal document that describes the processes and procedures where a settlor or grantor transfers his or her assets to a trustee, who manages the assets on behalf of a beneficiary. Trusts can be either revocable/living trusts or irrevocable trusts. Here, we are only discussing irrevocable trusts, and specifically irrevocable life insurance trusts.

Settlor or Grantor: The individual who establishes the trust or transfers property to a trust.

Trustee: A person or corporation who manages a trust for the benefit of a third person, the beneficiary, pursuant to the terms of the trust.

Beneficiary: A person who receives assets from a trust.

An irrevocable life insurance trust is an estate planning and asset protection device used specifically with life insurance policies, most often whole life insurance or universal life insurance that accrues a cash value. Irrevocable life insurance trusts can also be used for term life insurance.

However, by giving up the ability to amend, change or alter the irrevocable life insurance trust, you must be certain that the irrevocable trust is set up in a way that makes sense not only in the present time, but also well into the future.

Advantages to an Irrevocable Life Insurance Trust:

(1) Assets held by an irrevocable life insurance trust are generally not subject to the grantor's and beneficiary's claims, including nursing homes. This provides significant asset protection advantages to both the grantor and the beneficiary.

(2) An irrevocable life insurance trust can carry significant income tax advantages, specifically using the annual gifting limitations established by the Internal Revenue Service (IRS).

(3) There is a misunderstanding that life insurance is not taxable under any circumstances. Life insurance proceeds are not subject to income tax, but they can be subject to other taxes, such as estate taxes. An irrevocable life insurance trust can, in addition to income tax advantages, carry significant estate tax advantages.

Disadvantages to an Irrevocable Life Insurance Trust:

(1) A will is still necessary. A pour over will is still required if you have an irrevocable life insurance trust. This is required because an irremovable life insurance trust cannot appoint a guardian for minor children like a will.

(2) The beneficiary designation on the life insurance policy must be made payable to the irrevocable life insurance trust. If this designation is not made, the irrevocable life insurance trust will not provide much of a benefit.

(3) Proper procedures, such as Crummey Letters, trust accounting, and handing of the irrevocable life insurance trust's assets must be followed, but are often disregarded, which will eventually pose numerous legal and tax issues.

(4) Irrevocable life insurance trusts cannot be altered, amended or changed. This includes changing the beneficiaries or the trustees.