What is an irrevocable life insurance trust?
Updated 12:12 p.m. UTC Sep. 27, 2023
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Key points
- An irrevocable life insurance trust can hold your life insurance policy and help avoid estate taxes.
- The trust takes control of your policy though your beneficiaries would still get the death benefit.
- These may become more relevant to more people if and when estate tax limits lower.
An irrevocable life insurance trust (ILIT) is a financial product that allows you to separate your life insurance from your estate.
“If you set up an ILIT, the idea is that the value of the life insurance is not included in your estate for tax purposes,” says Patrick Simasko, an elder law attorney and financial advisor at Simasko Law in Mount Clemens, Mich. That, he explains, can help you avoid things like estate taxes, and potentially gift or inheritance taxes, if those exist in your state.
The payout is not subject to federal taxation, but, if not in an ILIT, is included in the total value of the deceased’s estate. If the money comes out of the ILIT instead of directly from the insurance company, it won’t count as part of your estate, and will result in lower taxes.
How does an irrevocable life insurance trust work?
When you get an ILIT, you’re signing over ownership of your life insurance policy to a trust.
Once you’ve handed over control, the ILIT would pay the premiums, keeping the policy active. Similar to a traditional life insurance policy, your beneficiaries would still get the death proceeds when the time comes.
One key thing to be aware of here is the ‘irrevocable’ part of the trust: In most cases, you won’t be able to make any changes to the trust once it’s set up.
You don’t have to put funds directly into your ILIT. An unfunded ILIT is one that holds a life insurance policy only, and nothing else. You will, however, have to gift money to the trust so it can pay the policy premiums.
You can add additional funds to your ILIT while alive. Those assets will also be shielded from estate taxes, though the assets you put in there may be subject to gift and income tax consequences.
An ILIT consists of three essential roles:
- Grantor: This is the individual who establishes and funds the trust, also selecting a trustee to oversee its operations.
- Trustee: This individual is responsible for covering the life insurance premiums, collecting the death benefit upon the grantor’s demise, and distributing the proceeds to the named beneficiaries.
- Beneficiaries: These are the individuals or entities selected by the grantor to benefit from the life insurance policy held by the ILIT.
Cons of an irrevocable life insurance trust
According to Wealth Advisors Trust Company, the one-time set up fee for the trust is $750 and there is an annual fee of $3,000 for one life insurance policy. Additional policies cost $500. These costs can vary.
When is it a good idea to get an irrevocable life insurance trust?
If you have a large estate—at or around $11.4 million for a single person—an irrevocable life insurance trust can be a useful financial tool to minimize your estate taxes while ensuring that your beneficiaries get your full life insurance payout. However, it’s important to note that although estate taxes are currently set at $11.4 million for an individual (or double that amount for a couple), that may not always be the case. In fact, in 2026, the limit will revert back to the previous limit of $5 million per individual, unless new legislation is introduced.
If your estate is worth multiple millions of dollars, and especially if it’s growing rapidly, you may want to look into this product.
Ethos
Who qualifies for an irrevocable life insurance trust?
There isn’t necessarily a qualification or requirement to get an ILIT. But since it’s going to cost money, you’ll want to make sure that you’re getting the tax benefits of the product. Otherwise, it won’t be doing anything useful for you.
Pros and cons of an irrevocable life insurance trust
Pros
- For high-net worth individuals, it can lower the value of your estate and help you avoid estate taxes.
- It can help future-proof your finances since estate tax rules may change as you get older.
- An ILIT can provide protection for your life insurance policy against divorce and legal action against you or your beneficiaries.
Cons
- You may pay costly fees, like a setup fee as well as annual fees.
- ILITs are a complex estate planning tool, so you may have to get a lawyer who specializes in the product to ensure it’s set up correctly.
- You must give away control of the life insurance policy.
Irrevocable life insurance trust FAQs
An ILIT is an estate tax planning tool that can help minimize the size of an estate.
You won’t have any control over your life insurance policy once you sign over ownership to the ILIT. Plus, the terms of the ILIT are irrevocable, too.
In general, no, you cannot terminate an ILIT once it’s been set up. However, there may be circumstances where you can — for example, by court order.
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