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Irrevocable Life Insurance Trust as an Estate Planning Tool

Purpose of an Irrevocable Life Insurance Trust (“ILIT”)

Typically, proceeds from a life insurance policy are included in the owner’s gross estate for estate tax purposes. Common triggers for incorporating the insurance policy into the gross estate are when proceeds from the policy are payable to the decedent’s estate or the decedent retained any incidents of ownership over the policy.

The purpose of an ILIT is to avoid inclusion of insurance proceeds when calculating the insured’s gross estate.  An irrevocable funded life insurance trust removes the proceeds of the life insurance policy along with other funds in the trust from the settlor’s estate. If properly created, an ILIT vests all ownership in the trust. The benefit of vesting all ownership in the trust is to exclude the value of the life insurance policy from the insured’s estate. An ILIT creates a separate source of cash to cover the estate tax, all while avoiding the anticipated estate tax due from increasing the value of the trust.

The ILIT is an effective estate planning tool because it enables the proceeds from a life insurance policy to be excluded from the insured’s estate; however, the insured must surrender control of the life insurance policy. The settlor (person making the trust) cannot retain any incidents of ownership in the property held in the trust. Incidents of ownership includes a reversionary interest where there is a possibility that the proceeds of the policy may return to the decedent or his estate. For example, incidents of ownership include the ability to surrender or cancel the policy, change the beneficiary, assign the policy, use the policy as collateral for a loan, borrow against the policy’s cash value (as is usually the option with most whole life policies), or change the method of payment in the insurance proceeds.

Creation of ILITS

In short, an insurance policy is created for the life of the settlor and ownership of the policy is given to the trust. However, there are many technical steps and procedures to follow in order to correctly administer an ILIT. In addition, there are many decisions the settlor must make prior to structuring an ILIT, such as (i) what type of life insurance to use to fund the trust; (ii) whether to create a joint or separate ILIT; (iii) whether to purchase a new insurance policy or transfer an existing policy into the trust; and (iv) who should be listed as beneficiaries.

First, it is significant to mention that once a settlor has determined they wish to create an ILIT, the initial step is to create the trust. It is imperative to create the trust first, particularly if the settlor has decided to purchase a new insurance policy to fund the trust, because it is the trustee who should purchase the new policy for the life of the settlor. The settlor can also use an existing insurance policy; however, taxes may be imposed on the transfer and the settlor must survive the transfer by three years.

Types of Insurance Policies

The types of life insurance policies typically suggested for ILITs: term insurance, whole life insurance, and universal life insurance. It is important that in conjunction with implementing this strategy a person should reach out to a registered life insurance agent to best understand the working of any life insurance policy.

Term life insurance lasts for a specified period of time and then expires. Term insurance plans are typically 10, 20, or 30 years in length and the premiums paid are fixed for the specified period. After the period selected has expired, the insurance company may offer the owner the opportunity to extend the term, but the insurance company also has the right to significantly raise the premiums if the individual wants to continue with coverage. Some companies do not offer 30-year plans or do not offer these plans to older aged individuals. The most significant benefit of term insurance is the lower premium payments. While term insurance provides for cheaper premiums, term insurance may not be advisable for use in an ILIT since there is a possibility that the insured may outlast the term, defeating the purpose of an ILIT.

Permanent insurance is life insurance that guarantees coverage for the life of the insured. Typically, permanent insurance policies are offered in the form of whole life or guaranteed universal life insurance policies. Recently, life insurers have also offered hybrid policies that blend multiple coverages to balance cash accumulation goals with end-of-life coverage. Whole life insurance policies generally have the highest premiums for life insurance coverage, but they come with certain advantages, such as cash value that can be accessed by the beneficiaries while the insured is still alive. Whole life policies tend to keep up with inflation better, as the insurance amount of coverage can increase over time. Whole life policies are usually a good choice for an ILIT; however, if the settlor is using an existing whole life policy to fund the trust, the transfer may be subject to a tax to get the policy into the trust. Also, people considering whole life insurance should attempt to be realistic about how much they truly can afford to pay in premium so as not to put themselves in a position where they cannot afford to fund the policy.  In addition, it is imperative that the person considering whole life insurance insist on using a reasonable rate of interest in assessing the in force illustrations to make sure the policy doesn’t implode for failure of the insured to properly fund the policy.

Guaranteed universal life insurance policies come in different forms, but typically the focus on these policies is for less expensive premiums than whole life policies for the same amount of life insurance coverage; often without the cash value. Universal life insurance policies typically offer a fixed death benefit, although an increasing death benefit can be purchased for an additional fee. Universal life policies are also good for funding an ILIT; however, transferring an existing policy into the IILT may face the same taxes as transferring a whole life policy. Irrespective of the type of insurance chosen, the owner and beneficiary of the policy must be properly recorded. The owner and beneficiary of the policy should always be the ILIT trust itself.

The amount of life insurance depends on the individual and their circumstances, but if the purpose of creating an ILIT is to avoid federal estate tax, the anticipated estate tax due should be considered.

Type of ILIT (Joint or Separate)

Another decision the settlor must make is whether they want a joint or separate ILIT. If the settlor is not married, the only option available is a separate ILIT. If the settlor is married, the settlor must choose between either a joint or separate ILIT.

A joint ILIT is funded with a joint and survivor life insurance policy, meaning that the policy insures both lives of the spouses and the death benefit on the policy is only paid out to the trust upon the death of the second spouse. Usually joint life insurance policies provide for more coverage at a lower premium since the life insurance policy does not need to be paid out until both insureds are deceased. This policy is commonly used for estate tax planning purposes. Typically, if the settlor is married, an individual ILIT may not be beneficial, because when a spouse dies, assets can pass to the surviving spouse with an unlimited marital deduction. If the spouses are both U.S. citizens, there is an unlimited marital deduction available for estate tax purposes, in other words, federal estate tax is not due upon the death of one spouse when assets are transferred to the surviving spouse; instead the estate tax is levied when the second spouse passes.

A separate ILIT is funded with a life insurance policy for the life of one individual, the settlor. A separate ILIT is useful when the settlor is transferring an existing life insurance policy for the life of the settlor into the trust. One of the drawbacks to a separate ILIT is that premiums are often much higher than a joint insurance policy and once the first spouse passes, assets in the trust may be exhausted during the life of the second spouse, leaving little remaining for the other generations.

New or Existing Life Insurance Policy

The settlor must also decide whether they want to apply for a new insurance policy to fund the ILIT or simply transfer an existing policy into the ILIT. If possible, it is preferable to fund the ILIT with a new life insurance policy instead of an existing policy, because transferring an existing policy into the trust may be subject to tax when the transfer is made and the settlor must survive the transfer by three years to be excluded from the settlor’s estate. However, there are circumstances where purchasing a new policy is not possible or would be very cumbersome on the settlor and transferring an existing policy is the only option.

If the settlor has decided to fund an ILIT with a new insurance policy, is it important the settlor not purchase the policy themselves; the trust needs to be formed first and the trustee should purchase the new policy for the life of the settlor.

Maintaining the ILIT (Beneficiaries and Withdrawal Notices)

Because the purpose of an ILIT is to avoid including proceeds from a life insurance policy in the settlor’s estate, it is essential that the settlor’s estate is not named as a trust beneficiary. If the settlor has a joint ILIT, the surviving spouse cannot be listed as a beneficiary either (this is because the insurance policy for a joint ILIT is on the life of both spouses, thus if one spouse is listed as a beneficiary they are retaining an incident of ownership). If the settlor has a separate ILIT, the surviving spouse may be listed as a beneficiary, but the ILIT should be drafted to limit the surviving spouse’s access and control of the assets inside the trust, otherwise the life insurance proceeds will be calculated into the surviving spouse’s estate.

Further, for transfers to the ILIT to qualify for the annual gift tax exclusion, the beneficiaries must be given withdrawal rights. These withdrawal rights are called Crummey withdrawal rights and are rights granted to beneficiaries allowing them to withdraw certain amounts from the trust during a specified period of time. For the annual gift tax exclusion to apply to trust contributions, the beneficiaries must be notified of their withdrawal rights and be given a reasonable amount of time to exercise their withdrawal rights. It is irrelevant whether beneficiaries exercise their withdrawal rights (typically beneficiaries will not exercise their withdrawal rights in order to maintain enough funds in the trust), the crucial issue rests on the beneficiary possessing the legal right and is given a reasonable amount of time to withdraw.

An ILIT is an advanced estate planning technique, and it is not for everyone because of its complexity, inflexibility, and costs associated with creating and maintaining the trust. Also, given that the federal exemption is currently $11.4 million, there are fewer people in need of estate planning techniques to avoid estate taxes compared to prior years. Irrevocable Life Insurance Trusts should be created when the settlor has an estimated estate tax liability and would prefer to purchase an insurance policy to pay for the estate tax. The premiums for the insurance policy, regardless of the type of insurance chosen, are typically much less than the federal estate tax owed.


Irrevocable life insurance trusts are not an effective strategy for everyone and may not be appropriate for every situation, due to the fees, complexity, and inflexible nature of ILITs. The creation of an ILIT involves substantial legal fees not only to establish the trust but also to administer and to ensure that withdrawal notices are timely sent out for the trust. The fees incurred in creating the trust could in some cases defeat the overall purpose of avoiding taxes.

One of the most important concerns associated with ILIT’s are the fact that they are irrevocable and very inflexible. Once the settlor surrenders property to the trust, it no longer belongs to the insured. Individual circumstances change and financial situations fluctuate. Another concern is whether the ILIT will be properly drafted. If an ILIT is not properly drafted or administered, the purpose of avoiding the estate tax will not be accomplished and proceeds from the life insurance policies will be included in the decedent’s estate. Most commonly, an ILIT can fail when the settlor or trustee incorrectly fills out the insurance paperwork and the settlor by mistake retains incidents of ownership in the policy or either party fails to list the ILIT as a beneficiary.  Another common reason irrevocable life insurance trusts fail is when the settlor transfers an existing life insurance policy into the trust and the settlor passes away within three years. When this happens, the proceeds are the policy are considering to be a part of the decedent’s estate and is calculated into the total gross estate for estate tax purposes.


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