Do you need an irrevocable life insurance trust?

Did you know only 0.07% of estates end up owing federal estate tax?1

While that number may seem low to you, the federal estate tax exemption is currently at its highest level ever ($11.7 million per person, aka $23.4 million for married couples, in 2021).

Another reason that number is low? Strategy. There are a range of strategies you can use to minimize federal (and state, where applicable) estate taxes — one of which is the irrevocable life insurance trust (ILIT). And for those individuals who, even through proactive planning, will still end up owing an estate tax, having permanent life insurance owned by an ILIT can help provide liquidity at death to pay that estate tax liability.

If you’re wondering if you should be leveraging an ILIT or when you might need one, we can help:

What is an irrevocable life insurance trust?

An ILIT is a trust that is created to own a life insurance policy on behalf of the insured. It is a completely separate entity and is considered outside of an individual’s gross estate — it even has its own tax ID number.

The ILIT not only owns the life insurance policy but is also the beneficiary. When the insured person passes away, the policy’s death benefit is kept out of their gross estate (subject to applicable limitations) and therefore not subject to estate taxes.

What are the benefits of an ILIT?

The main reason to create an ILIT is if you have a taxable estate or expect to have one in the future.

One major benefit is that by removing your life insurance’s death benefit amount from your gross estate, you can reduce or potentially eliminate estate tax that will be owed.

Another benefit is that even if your estate is large enough to get hit with estate taxes, the death benefit could be used to provide liquidity at an individual’s passing to pay the taxes owed.

As a trust, an ILIT also gives you greater control over the distribution of the trust’s assets (i.e., death benefit). You can customize the trust language when setting the document up with a qualified estate planning attorney in many different ways, such as giving different percentages to different beneficiaries, distributing the money at different times in different amounts, restricting what age the beneficiaries need to be to access the money and even restricting what they can use the money for (for example, limiting the death benefit use to education expenses). The ILIT also provides beneficiaries with creditor protection, which is an added benefit.

Lastly, assets in a trust do not have to go through probate, which helps avoid prolonging what can be a time-consuming and expensive process.

When should you avoid creating an ILIT?

This may surprise you, but your age does factor into whether you should pursue setting up an ILIT. Because of the three-year lookback rule, if the insured passes away within three years of transferring an existing policy into the ILIT to fund it, the death benefit is included in the insured’s gross estate — which negates the ILIT’s main benefit. One important item to note here is that the three-year lookback rule does not apply to new life insurance policies that are purchased by the ILIT.

Few people know when they’re going to pass away, but the three-year lookback rule does present a certain amount of risk for those who are older and/or have health issues.

When else should you avoid ILITs? Well, if you don’t expect to have a taxable estate, there are other options that may work better for your specific situation and goals. It takes time and money to create and fund an ILIT, and there are quite a few rules you need to adhere to.

The impact of legislation

Keep in mind that if you don’t have a taxable estate now, it doesn’t mean you won’t in the future. In 2017, the Tax Cuts and Jobs Act (TCJA) raised the individual estate tax exemption from $5.49 million to $11.18 million. But that sunsets on December 31, 2025, and returns to $5.49 million (adjusted for inflation). What’s more, the current presidential administration has proposed lowering the exemption to $3.5 million.

The SECURE Act has complicated matters, too. It requires those who inherit an IRA account to take all the money out of the account via required minimum distributions within a 10-year window. That could lead to heirs owing quite a lot of income tax on IRA accounts. In lieu of leaving retirement accounts to their heirs, it’s growing more common for people to create ILITs and leave their heirs a large, tax-free death benefit instead.

Note that you can name a trust as the beneficiary of your IRA, and you can read more about that here.

What do you need to know about setting up and funding an ILIT?

Once you decide to move forward with an ILIT, you’ll need an estate planning attorney to draft the trust documents, and you’ll need to choose a trustee to administer the trust and adhere to its rules.

Then, when it’s set up, you’ll need to fund it. There are two common ways to fund an ILIT. The first is to transfer a preexisting life insurance policy into the ILIT. (Note that doing so could subject you to gift taxes.) The second route is to have the ILIT purchase a brand-new life insurance policy.

Because the trust owns the life insurance policy, the trustee must pay the ongoing premium (if applicable). Typically, the grantor gifts the premium amount to the trust (note, the trustee must set up a separate checking account owned by the ILIT). These gifts are subject to the annual gift exclusion amount, which lets an individual gift up to $15,000 to another individual without incurring the gift tax. For example, if your ILIT has four beneficiaries, this means you could gift up to $60,000 per year to the ILIT tax-free.

Although these gifts are used to pay the premium, the beneficiaries can be granted a right to withdraw the funds (known as “Crummey Rights” or “Crummey Powers”). This ability to withdraw the funds for a set period of time enables the gifts to count as present-interest gifts under the annual exclusion. However, the trustee must send a Crummey letter to each beneficiary every time the grantor makes a gift to the ILIT informing them of their right to exercise these Crummey Powers.

Requirements like Crummey letters are part of the rules of administering an ILIT, so make sure the trustee you choose is familiar with all the requirements and is capable of adhering to them.

Wipfli Financial can help you get started

Does an ILIT make sense for you? We can help you make that determination. Our financial advisors look at your potential estate tax exposure within the context of your overarching financial plan to determine whether an ILIT is a beneficial strategy for you to use. Contact us to get started.

Related content:

3 reasons high-net-worth families should review estate tax planning now
Estate planning steps for each stage of your life
What is a GRAT, and why is now a great time to set one up?
Surviving a spouse is never easy. Here are 8 tax, estate and financial planning tips to prepare


Do you need an irrevocable life insurance trust

Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC); however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services, fees and conflicts of interest is set forth in Wipfli Financial’s current Form ADV Part 2A brochure and Form CRS, copies of which are available from Wipfli Financial upon request at no cost or at Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Kyle Griffith

CFP® | Financial Advisor

Kyle Griffith is a Financial Advisor with Wipfli Financial Advisors, LLC, based in the Chicagoland area.

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Do you need an irrevocable life insurance trust?

time to read: 5 min