An Irrevocable Life Insurance Trust (ILIT) is an effective estate planning strategy designed to minimize estate taxes, ensure liquidity for estate-related expenses, and safeguard life insurance proceeds from creditors. By transferring ownership of a life insurance policy to an ILIT, the policy’s death benefit is excluded from the insured’s taxable estate, maximizing the amount beneficiaries receive without estate tax implications.

ILITs are particularly beneficial for individuals with substantial assets who aim to reduce tax burdens, provide financial security for their loved ones, and establish a reliable source of funds for estate settlement costs or inheritance. Let’s explore the key benefits and important considerations of implementing an ILIT.

• Estate Tax Reduction: If a policy is owned by the insured at the time of death, its proceeds are typically included in the taxable estate. Transferring ownership to an ILIT removes the death benefit from the estate, potentially saving heirs significant amounts in estate taxes.
• Liquidity for Estate Costs: ILITs offer a financial cushion for paying estate taxes, debts, and other obligations, preventing heirs from needing to sell valuable assets, such as real estate or business interests, to cover these expenses.
• Creditor Protection: Because the trust, not the individual, owns the life insurance policy, the proceeds are shielded from creditors of both the insured and the beneficiaries.
• Controlled Distribution of Assets: The grantor can dictate how and when the trust distributes funds, ensuring responsible financial management for minor beneficiaries, those with special needs, or individuals who may not be financially savvy.
• Generation-Skipping Tax Planning: Structuring an ILIT to benefit multiple generations can help minimize or eliminate generation-skipping transfer (GST) taxes, preserving wealth over time.

• Irrevocable Structure: Once created and funded, an ILIT cannot be changed or revoked. You lose control over the life insurance policy and any other assets placed in the trust.
• No Access to Cash Value: If the policy is a permanent one (like whole life), you can’t borrow or withdraw from the cash value—those funds belong to the trust, not to you.
• Gift Tax Implications: Premium payments made on behalf of the ILIT may be considered gifts to beneficiaries. Annual gifts must qualify for the annual gift tax exclusion, which requires proper notice (typically via Crummey letters) to beneficiaries.
• Three-Year Rule for Existing Policies: If you transfer an existing life insurance policy into the ILIT, you must survive at least three years for the death benefit to be excluded from your estate (IRC §2035). This can create risk if the insured is in poor health at the time of transfer.

Establishing an ILIT involves several key steps. First, the grantor, with legal assistance, creates an irrevocable trust, relinquishing all control over the trust and the insurance policy once it is transferred. Next, the trust either purchases a new life insurance policy or an existing policy is transferred to the ILIT. If an existing policy is transferred, the grantor must survive for at least three years to prevent estate inclusion under the IRS’s three-year look-back rule. To maintain the policy, the grantor makes annual contributions to the trust to cover premium payments. Beneficiaries receive Crummey Notices, which temporarily grant them the right to withdraw these contributions, allowing the contributions to qualify for the annual gift tax exclusion. Upon the insured’s passing, the death benefit is paid directly to the ILIT, and the trustee administers the funds based on the trust’s terms, which may include estate tax payments or structured distributions to beneficiaries.

• Estate Taxes: Since the ILIT owns the policy, the proceeds are excluded from the insured’s estate, potentially reducing estate tax liabilities.
• Gift Taxes: Contributions to the ILIT to cover premiums are considered gifts but can qualify for the annual gift tax exclusion ($17,000 per beneficiary in 2023) if Crummey Notices are properly executed.
• Generation-Skipping Transfer Taxes: If structured to benefit multiple generations, an ILIT may require GST tax planning to maximize wealth preservation.

• Irrevocable Nature: Once established, the ILIT cannot be changed or revoked. Careful planning is essential before creating the trust.
• Trustee Selection: The trustee manages policy premiums, Crummey Notices, and distributions. Choosing a reliable individual or professional institution is crucial.
• Compliance with IRS Regulations: Proper execution of Crummey Notices and adherence to the three-year rule for existing policies help avoid unintended tax consequences.
• Sufficient Funding: Regular contributions must be made to cover insurance premiums, ensuring the policy remains active.

An Irrevocable Life Insurance Trust (ILIT) is a valuable tool for estate planning, offering tax advantages, asset protection, and structured wealth distribution. By working with financial and legal professionals, individuals can establish an ILIT that aligns with their estate planning objectives, ensuring long-term financial security for their heirs.

Disclosure: This material is for informational purposes only and should not be considered tax, legal, or financial advice. Individuals should consult with qualified professionals before implementing any estate planning strategies.

Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. Advisory services offered through Sanctuary Advisors, LLC., an SEC Registered Investment Advisor. Burnham Harbor Private Wealth is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC.