Irrevocable life insurance trusts can be a helpful component of an estate plan to reduce tax liability and provide liquid funds to meet final expenses.

Your goals and your family situation are like no one else’s, and that is why the team at Blacksburg Law designs estate plans based on your specific needs and goals. For some individuals, an irrevocable life insurance trust or ILIT is a helpful component to add to an estate plan while for other individuals, different estate planning strategies might work better to accomplish critical goals.

Before you can decide whether an ILIT would be the right option for your situation, it is helpful to understand how these trusts operate and what they are designed to accomplish.

Understanding Irrevocable Trusts

An ILIT is one of many types of irrevocable trusts that estate planning attorneys use to achieve clients’ objectives. If you think of a trust as a container that holds property, a revocable trust is like an open basket you can reach into freely to take out property while an irrevocable trust is more like a drop box at a bank. The drop box is very secure, so it protects the property inside. However, once you drop something inside, you cannot pull it back out again. It stays in the box until the person with the key—in this case, the trustee—removes it. Like a bank employee removing cash from a dropbox, the trustee of an irrevocable trust has access to and control of the property inside the box, but it is not theirs to use for their own purposes. Instead, they must direct the property in the way the trust creator has directed.

People use revocable trusts as a tool to avoid probate. Irrevocable trusts are generally used to protect assets in some way. Since the trust creator loses access to assets after they transfer them into the trust, those assets are no longer considered to be theirs. This means creditors cannot take those assets, and they are not considered part of the trust creator’s estate for tax purposes.

ILITs are Created to Hold Life Insurance Policies

People establish ILITs to own life insurance policies. The creator of the trust might transfer an existing policy into the trust or the trust might buy the policy. Generally, the person who created the trust continues to pay the premiums on the policy through gifts to the ILIT on behalf of the ILIT beneficiaries.

When the person who created the trust passes away, the proceeds of the life insurance policy are paid to the policy beneficiaries. These beneficiaries are often family members, but they can be anyone.

However, the provisions in the trust document might specify that proceeds should be used for a particular purpose. For instance, the trustee might be directed to use funds to cover funeral expenses, probate costs, taxes, final medical bills, and debts left behind. This would prevent the estate from needing to sell assets to meet those expenses.

Because the policy is held by the trust rather than the trust creator, none of the value is counted toward the value of the estate for purposes of estate tax liability. Beneficiaries can receive proceeds without funds being depleted by estate tax.