Make Life Less Taxing with an ILIT

For many families, life insurance is an important part of their financial security. But in some circumstances, a life insurance policy can have taxing consequences on a family’s estate.

While it’s certainly true that the beneficiaries of your life insurance policy will receive the funds completely tax free, that doesn’t mean it will necessarily be tax free to you. A little known fact is that your policy’s death benefit is included in the value of your estate for the computation of your estate tax liability at death. Since families often own policies with face amounts worth hundreds of thousand of dollars, overlooking this asset in the estate planning process can be a costly mistake.

Fortunately, a relatively simple solution allows you to maintain the level of life insurance coverage you need to insure your loved ones’ financial security without adding to your estate tax liability. It’s called the Irrevocable Life Insurance Trust (ILIT for short), and it keeps your life insurance policy out of your estate without sacrificing your ability to control who, what, when and how the proceeds are eventually distributed.

Once your estate planning attorney drafts your ILIT, you either transfer ownership of an existing life insurance policy to the ILIT or secure a new policy on your life with the ILIT as owner. Each year you’ll pay the policy’s premiums on behalf of your beneficiaries using your annual gift tax exemption of up to $13,000 per donee per year.

Although you don’t actually own your life insurance policy, you retain the ability to name the policy’s beneficiaries, and, as an added benefit, you can completely control when, how and why they receive policy distributions. Individuals who don’t expect to have taxable estates at death, and thus, don’t need the ILIT’s tax savings, often find that this control over how loved ones receive the proceeds is reason enough to have one. With an ILIT, for example, you can direct a trustee to pay your beneficiaries a set amount of money each year. Or you can stipulate that your loved ones receive the policy’s proceeds only upon attaining certain milestones or for specific purposes, such as a college education, the birth of a child, the purchase of a new home, etc. In this way, the ILIT provides you with a tool to help manage your loved ones’ financial security long after you’re gone.

We’ve greatly simplified the discussion here, and you should be aware that there are strict IRS requirements that must be followed to secure the tax advantages of the ILIT. Nonetheless, it can be a highly effective estate planning tool for many families. If you think it might be appropriate for you, please be sure to give us a call