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An Irrevocable Life Insurance Trust (ILIT) is a type of irrevocable trust designed to own one or more life insurance policies on the life of the grantor (the insured) and to manage and distribute policy proceeds to beneficiaries according to the trust terms. The ILIT is typically used to provide liquidity for estate taxes, preserve wealth for heirs, and control how and when benefits are paid.

Structure and operation: The grantor funds the ILIT with gifts, which the trustee uses to purchase and maintain the life insurance policy and to pay premiums. The ILIT is the policy owner and beneficiary, while the trustee administers distributions to named beneficiaries. Crummey provisions are often included so premium gifts qualify for annual gift tax exclusions.

Tax considerations: Because the ILIT owns the policy, the death benefit can, with proper design, be excluded from the grantor’s estate for estate tax purposes. Premiums funded by the grantor are gifts to the ILIT and may be subject to gift taxes, though exclusions apply. Death proceeds paid to the ILIT are generally not subject to income tax, but any investment income earned by the trust is taxed to the trust; distributions to beneficiaries may shift the tax burden depending on the trust’s structure and the beneficiaries’ tax situations. The five-year rule and potential incidents of ownership are important considerations in ensuring the intended tax outcome.

Uses and limitations: ILITs are commonly used by individuals with large estates or liquidity needs to pay taxes, fund buy-sell agreements, or provide for heirs while maintaining control over distributions. The irrevocable nature means limited flexibility and ongoing administration, often requiring professional guidance.

See also: estate planning, trusts, life insurance, irrevocable trust.