ILITs

An irrevocable life insurance trust (ILIT) is an estate planning vehicle designed to own a life insurance policy outside the grantor’s personal estate. The primary purpose is to provide liquidity for the payment of estate taxes and other expenses, while potentially reducing estate taxes and preserving wealth for beneficiaries.

In an ILIT, the trust is the policy owner and the beneficiary of the policy. The grantor funds the trust by making cash gifts that are used topay the insurance premiums. A trustee administers the trust and, with the policy proceeds, distributes assets to the beneficiaries according to the trust terms. Because the policy is owned by the ILIT and not by the grantor, the death benefit is generally not subject to the grantor’s estate taxes. The structure is commonly used to provide tax-free liquidity for heirs and to minimize the value of the grantor’s taxable estate.

Tax considerations include the treatment of premiums as completed gifts to the ILIT, which can qualify for annual gift tax exclusions if the contributions are made under Crummey withdrawal powers. These powers allow beneficiaries to withdraw a stated amount within a limited period, ensuring the gifts qualify for the annual exclusion. Upon the insured’s death, the policy proceeds go to the ILIT and are distributed under the trust’s terms, typically free of income tax and potentially shielded from estate taxes, depending on applicable law and timing.

Advantages of ILITs include liquidity to cover estate taxes, enhanced control over how proceeds are distributed, and potential tax efficiency. Drawbacks include loss of ownership and control over the policy, ongoing administrative costs, and the need for disciplined funding to prevent policy lapse. ILITs are often part of broader estate plans and are chosen based on the individual’s goals and tax situation.