Advanced planning

Life insurance trusts

Protecting your client’s legacy is an important estate planning goal. Estate taxes and creditors can threaten to deplete your client’s wealth. If these are important considerations for your client, your client may be interested in a wealth preservation and protection strategy known as an Irrevocable Life Insurance Trust (ILIT).

What is it?

An ILIT is an irrevocable trust that goes beyond basic estate planning. While an ILIT can hold many different assets, it is primarily designed to hold life insurance. When structured properly, policy insurance proceeds pass free of both estate and income taxes and are shielded from many types of creditors.

Estate tax management

Taxable estates are subject to a top federal estate tax rate of 40% under current law. Moreover, roughly one-third of states impose a separate estate tax which can impact even modest estates. A properly funded ILIT can help mitigate (or eliminate) the tax burden.

Creditor protection

ILITs are an excellent planning vehicle for creditor protection in many states. If your client works in a high-risk profession or are otherwise concerned about creditors, an ILIT may be appropriate to help your client manage risk. ILITs can also offer creditor protection for your client’s beneficiaries who may have concerns of their own.

How does it work?

Your client and their estate planning attorney establish an ILIT that fits their needs. As the trust’s creator, your client is known as the “grantor.” Your client appoints a trustee to manage trust assets and make distributions to beneficiaries. The ILIT will own and be the beneficiary of a life insurance policy (typically on your client’s life). Each year, your client gives funds to the ILIT to pay policy premiums.

At the death of the insured, the trustee receives tax-free life insurance proceeds and manages or distributes the funds to beneficiaries according to the terms of the trust document.

The benefits

• Life insurance policy proceeds pass free of both estate and income taxes in a properly structured ILIT, making this a powerful wealth transfer technique for the benefit of your client’s heirs.
• ILITs are a highly effective way to provide liquidity to your client’s estate. The trustee can typically make loans to or buy assets from your client’s estate, providing a mechanism for much-needed liquidity for estate settlement needs.
• ILITs can be structured with a lifetime payout for your client’s beneficiaries. This can be a powerful alternative to the Stretch IRA, a common planning technique eliminated by the SECURE Act for many non-spouse beneficiaries.
• The trust can be designed to delay distributions to beneficiaries who need assistance with asset management or who are concerned about creditor or divorce.
• The funds your client gifts to the trust each year to pay policy premiums can be structured to take advantage of annual gift tax exclusion amounts, making this a powerful leveraging technique.

Additional considerations

• In most cases, your client should not be the trustee of their own ILIT.
• ILITs are irrevocable and can be very difficult to change. However, the ILIT can be drafted with language to provide some flexibility. For example, the trust might give your client the power to substitute assets of equivalent value at a later date.
• As a general rule, your client will not have access to policy cash values for their own benefit. Your client can add their spouse as a trust beneficiary using a type of ILIT known as a Spousal Lifetime Access Trust (SLAT), unlocking access for the benefit of their spouse for limited purposes (typically health, education, maintenance and support).
• If your client gives an existing life insurance policy to their ILIT, the estate tax benefits are generally only realized if the insured outlives three years following the gift.
• Creditor protection varies by state. If creditor protection is a concern for your client, they should consult their attorney to discuss their particular situation. As a general rule, it is best to create an ILIT well in advance of any potential creditor claims or lawsuits.
• Your client should work closely with their attorney and tax professional to make sure they and their trustee have the appropriate documents and filings to maximize tax advantages of the ILIT.