Use an ILIT as a Wealth Preserver
If you’re concerned about your family’s financial well-being after you’re gone, life insurance can provide peace of mind. For example, purchasing life insurance to support young children may allow the surviving parent to be more available if the primary wage earner dies unexpectedly. Likewise, having life insurance to pay down an existing mortgage gives the surviving spouse more flexibility in planning for reduced income or cash flow.
Going a step further and setting up an irrevocable life insurance trust (ILIT) to hold the policy offers additional estate planning benefits.
Asset protection
You may have concerns about how your beneficiaries will use the life insurance you plan to leave for their protection e.g. their money management skills. Providing funds for someone with limited abilities, or “special needs,” may be a specific intention. In such instances, an ILIT may be the answer. Why? Your loved ones won’t receive the proceeds directly, as they would if they were the policy beneficiaries. Rather, they are the beneficiaries of the ILIT trust, and the trust controls when they receive proceeds.
You can also establish conditions for distributing funds from an ILIT. As an example, you might instruct the trustee to withhold funds from a beneficiary who drops out of school or develops a substance abuse problem.
A properly drafted ILIT can also protect trust assets against your and your beneficiaries’ creditors, particularly if it’s established in a state with favorable asset protection laws.
Estate tax savings
Placing your life insurance policy in an ILIT removes this valuable asset and its proceeds from your taxable estate. Creating the ILIT when you set up new life insurance coverage is preferred. Contributing an existing life insurance policy to an ILIT is possible, but may constitute a taxable gift to the trust beneficiaries of the policy’s fair market value (which generally approximates its cash value). With the combined gift and estate tax exemption currently at $5.49 million, now may be a good time to make such a gift.
Future ILIT contributions to cover premium payments will be taxable gifts. Typically, you may apply your annual gift tax exclusion (currently $14,000 per donee) to reduce or eliminate the gift tax reporting – provided the ILIT is structured appropriately and certain other requirements are met.
Bear in mind that a repeal of the federal estate tax has been proposed by President Trump and the Republican-led Congress. A repeal or other estate tax law changes could make the ILIT’s estate tax benefits less significant
Drawbacks
An ILIT does have some significant limitations. Once you transfer a policy to the irrevocable ILIT trust, you can no longer:
– Change or add beneficiaries,
– Assign, surrender or cancel the policy, or
– Borrow against or withdraw from the policy’s cash value.
In addition, you’re not allowed to alter the ILIT’s terms or act as trustee.
Nevertheless, you can design the trust with flexibility to adapt to changing circumstances and provide that children or grandchildren born after you establish the trust be automatically added as beneficiaries.
Contact us for additional details if you’re considering using an ILIT.