Irrevocable Life Insurance Trusts

A highly regarded estate planning tool is a device known as an Irrevocable Life Insurance Trust (“ILIT”). Establishing such a trust allows life insurance proceeds to escape estate taxes upon the death of the insured.


The proceeds from a life insurance policy are paid to the beneficiaries of the insurance policy income tax free. However, proceeds from an insurance policy owned by a decedent are included in the taxable estate of the decedent. So if your estate assets exceed the current estate tax exemption, excluding life insurance, any life insurance proceeds payable on your death will simply add to your taxable estate and approximately 50% of the proceeds will be lost to estate taxes.

How do you avoid tax on the life insurance? Instead of the decedent owning the life insurance policy, an ILIT may be created to own the policy, which if properly done, will exclude the proceeds from the decedent’s taxable estate. Thus, for example, if a $1 million policy is owned in the ILIT, there would be no estate tax due on the proceeds, and the entire $1 million would be available for your heirs. Use of such a trust can also be employed to bypass the estate of the decedent insured’s surviving spouse or of any other beneficiary for estate tax purposes.


In order to achieve the desired tax objectives, the insured creates an ILIT with someone other than himself or herself as the trustee. The insured then transfers either existing life insurance policies into the insurance trust or contributes money into the trust to enable the trustee to purchase a new policy on the insured’s life.

Where the insured is an owner of an existing policy, the insured must live for three years after the transfer in order to exclude the life insurance proceeds from his or her estate. There is no such limitation for a new policy purchased by the trustee.


Periodic contributions will be made to the insurance trust in order to pay the insurance premiums. It is important that these contributions be made from the insured’s separate property. With the proper documents, the insured’s spouse may give his or her community interest in the money to the insured, thereby converting the money to separate property. An insured spouse should deposit funds into a separate property account declared to be his or her separate property. Premium payments should then be made by check out of this account, preferably to the trustee of the insurance trust. This will ensure keeping all insurance policy proceeds payable as a result of the insured’s death out of both the insured’s and the insured spouse’s estate for estate tax purposes.


There are no gift tax or other tax consequences for the initial or subsequent contributions of money to the ILIT because the trust beneficiaries are given limited powers to withdraw contributions made to the trust. Current tax law requires these withdrawal rights to be given in order to qualify the gifts into the trust for the annual gift tax exclusion which allows each person to make gifts of up to $13,000 per calendar year per donee without having to pay a gift tax or file a gift tax return. If this withdrawal right with respect to gifts made to the trust were not given, such gifts would have to be reported on a gift tax return each year.

With regard to a beneficiary’s withdrawal right, the beneficiary is entitled to notice from the Trustee upon any contribution into the trust. This is generally accomplished by sending a beneficiary a written notice of the right to withdraw. The beneficiary then typically has 15 to 30 days to exercise the right of withdrawal. It is hoped, of course, that the beneficiary will not remove any such amount subject to withdrawal.


When the insurance proceeds are eventually paid into the ILIT, the insured directs in the trust document how the proceeds will be disbursed. Often the dispositive provisions in the trust will coincide with the insured’s will or living trust. The insured’s spouse and children, for example, may be given benefits immediately or the proceeds can continue in trust for their benefit over the time period and under the conditions set forth by the insured.

In the event the beneficiaries include minors, an ILIT provides another benefit. If no insurance trust exists and a minor is designated a beneficiary on the policy, an outright distribution will occur when the minor reaches eighteen. With an ILIT, however, you may have the insurance proceeds held in trust until the minor beneficiary reaches a more mature age to receive distribution.


You should consider an ILIT if you are single and your estate exceeds the current lifetime exemption amount. Congress began increasing the lifetime exemption in 2004. Currently the lifetime exemption is $3.5 million. In 2010, the amount becomes unlimited. However, unless Congress extends the repeal of the estate tax, the lifetime exemption will return to $1 million in 2011. Also, if you are married with an estate exceeding double the single person’s lifetime exemption amount, you should consider implementing an ILIT.

As you can see, an ILIT can be a valuable estate planning tool. To determine whether such a trust would be beneficial to you, please contact our office.