For some people, life insurance may not spring to mind immediately as an effective estate planning tool. A life insurance policy remaining in the estate of the
insured is subject to federal estate taxes. However, when carefully crafted and put in place with the guidance of an appropriate professional, there is a way both
to obtain the familiar benefits of a life insurance policy–providing a measure of financial security for the beneficiaries–and to remove the policy’s proceeds
from exposure to the estate tax. The vehicle is called an Irrevocable Life Insurance Trust (ILIT).
Here is how an ILIT works. At the core of the trust is the life insurance policy itself. The “grantor” of the trust makes annual gifts of sufficient money to pay the
premiums on the policy and to cover administrative costs, unless the trust is funded by other assets.
The legal owner of the policy is the trust, not the grantor, which explains how the insurance policy is treated as being outside of the grantor’s estate. The insured
cannot personally benefit financially. Another plus arising from the fact that the trust owns the policy is that this protects the funds from possible claims by the
beneficiary’s creditors.
As with any trust, an ILIT must have a designated trustee to manage and administer it. Typically, the trustee is a bank or a trust company, but practically any
person or entity other than the grantor can serve in that role. The trustee establishes a bank account into which the gifts will be deposited for use in paying the
premiums. The trustee is also responsible for a variety of administrative duties, including giving notifications to the beneficiaries under the policy and filing the
ILIT’s tax return.
Upon the death of the grantor, it is also the trustee who oversees distribution of the policy’s proceeds, in accordance with the grantor’s wishes as expressed in the
trust. This distribution can be all at once or spread out over time.
One of the appealing features of an ILIT is that it can be closely tailored to fit the wishes of the grantor regarding the conditions and circumstances for paying
out the proceeds of the ILIT. There are almost as many possibilities as there are individual grantors. For example, if the grantor is in a second marriage, the ILIT
proceeds might go to any children from the first marriage, with the rest of the estate going to the second spouse and the children from the second marriage. It is
also possible for the grantor to specify and achieve very specific purposes for the ILIT proceeds, with strings attached if desired. Think carrots and sticks: A
beneficiary might be in store for proceeds from the ILIT only if he or she satisfies certain conditions or meets certain goals. On the more negative side,
misconduct by a beneficiary could be used as an effective disqualification.
Bear in mind that an ILIT must comply with certain government rules and regulations if it is to achieve the desired results. Thus, aside from the potential
complexities of the instrument itself, the assistance of a professional is a must in navigating the government’s requirements for an effective ILIT.