Legal Definitions - irrevocable life insurance trust (ILIT)

An Irrevocable Life Insurance Trust (ILIT) is a specialized type of trust specifically designed to own a life insurance policy. The term "irrevocable" is key: once established, the person who created the trust (known as the grantor or settlor) generally cannot change, modify, or cancel its terms. This permanent structure allows the life insurance policy's death benefit to be held outside of the grantor's personal estate.

The primary advantage of an ILIT is to ensure that the life insurance proceeds are not subject to federal or state estate taxes upon the grantor's death, thereby maximizing the inheritance for beneficiaries. If a life insurance policy were owned directly by an individual, its payout would typically be included in their taxable estate, potentially leading to significant estate taxes if the total estate value exceeds the applicable exclusion amount. Additionally, like other trusts, an ILIT allows the grantor to appoint a trustee to manage the funds and dictate precisely how and when beneficiaries will receive the policy's benefits, providing control and protection for the inheritance.

• Example 1: High Net Worth Family Planning

  Scenario: Sarah is a successful entrepreneur with a net worth significantly above the federal estate tax exemption limit. She has a $5 million life insurance policy intended to provide substantial financial security for her children and grandchildren.

  Illustration: By placing her life insurance policy into an ILIT, Sarah ensures that the $5 million death benefit will not be included in her taxable estate when she passes away. If the policy were held in her name, that $5 million would be added to her other assets, potentially pushing her estate further into the taxable range and significantly reducing the amount her heirs would ultimately receive due to estate taxes. The ILIT's irrevocable nature guarantees this exclusion, providing her beneficiaries with the full, untaxed sum as she intended.

• Example 2: Business Succession and Liquidity

  Scenario: David owns a thriving manufacturing company and has a large life insurance policy. He wants the policy's proceeds to provide immediate liquidity for his business partners to buy out his share upon his death, ensuring a smooth transition, and also to provide for his family's living expenses during this period.

  Illustration: David establishes an ILIT to own his life insurance policy. This prevents the policy's payout from being tied up in probate or becoming part of his personal estate, which could delay access to funds for his business partners or family. The ILIT's trustee can be instructed to distribute funds to the business partners for the buyout and to his family for their immediate needs, all while avoiding estate taxes on the insurance proceeds. This structure facilitates a seamless business succession and provides crucial family support without tax erosion.

• Example 3: Protecting a Vulnerable Beneficiary

  Scenario: Maria has a substantial life insurance policy and wants to ensure her adult son, who has special needs and receives government benefits, is financially secure after her death without jeopardizing his eligibility for those benefits.

  Illustration: Maria creates an ILIT to hold her life insurance policy. She names a trustee and provides specific instructions that the funds should be used to supplement, rather than replace, her son's government assistance (e.g., for therapies not covered, recreational activities, or comfort items). Because the ILIT is irrevocable and owns the policy, the death benefit is not considered her son's personal asset, preventing it from disqualifying him from essential government aid. Furthermore, the funds are managed by the trustee according to Maria's wishes, protecting her son from potential exploitation or mismanagement of a large lump sum, all while avoiding estate taxes on the inheritance.