When is an Irrevocable Life Insurance Trust Right for Me?

By: Nicholas P. Crivella, Esquire and Tyler Zachry

An Irrevocable Life Insurance Trust (ILIT) can be a valuable estate planning tool, especially for individuals looking to manage estate taxes and provide financial security for their beneficiaries. Here are some key considerations to help decide if an ILIT is suitable for your needs:

  1. Why is an Irrevocable Life Insurance Trust Used?

An ILIT is primarily used to exclude life insurance proceeds from the insured’s taxable estate, thereby reducing the potential application of federal and/or state estate taxes. By transferring ownership of a life insurance policy to an ILIT, the death benefit is not considered part of the insured’s estate. The ILIT can provide liquidity to pay estate taxes and other expenses, ensuring that the estate’s assets are preserved for beneficiaries. Additionally, with careful planning, premiums paid towards the policy may qualify for the annual gift tax exclusion.

  1. Current Federal & State Tax Exemptions 

As of January 1, 2024, the federal estate tax exemption is $13.61 million per individual, with a 40% tax on all assets transferred in excess of this exemption. The federal estate tax exemption is currently set to decrease to $5 million indexed for inflation (likely around $6 million) on January 1, 2026. The Maryland estate tax exemption is currently $5 million per individual, with a 16% tax on all assets transferred in excess of the exemption. To the extent your taxable estate (inclusive of real estate, bank accounts, brokerage accounts, retirement accounts, closely held business interests, etc.) exceeds these exemptions, establishing an ILIT may be recommended to help reduce your taxable estate and your estate tax liability.

  1. Which Type of Life Insurance is Best Used to Fund a Life Insurance Trust?

Term life insurance is often recommended to fund an ILIT for those needing to cover short-term family liquidity needs. Term policies offer a cost-effective solution to provide immediate financial support in case of the insured’s death within the term period. However, permanent life policies, though more expensive, should be considered for long-term planning such as guaranteed estate tax liquidity, as they build cash value and provide permanent coverage. Second to die policies are often used to reduce the premium cost of a permanent policy.

  1. Choosing the Right Trustee

Selecting a competent trustee is crucial for the proper administration of an ILIT. The trustee’s responsibilities include:

  • Obtaining a Taxpayer ID Number.
  • Notifying beneficiaries of the trust creation.
  • Opening a bank account for the trust.
  • Receiving gifts equal to insurance premium amounts.
  • Issuing Crummey Letters to beneficiaries.
  • Making premium payments.
  • Potentially filing a gift tax return as advised by a CPA.

The trustee can be a trusted family member, a professional advisor, or an institution. Consider factors like experience, trustworthiness, and potential conflicts of interest when making this major decision. The members of Chesapeake Growth Network stand ready to assist businesses and individuals throughout the Chesapeake Corridor in navigating the nuances of the legal and financial landscape. Call us today for expert guidance towards your goals! 

Disclaimer: This article is not intended to be legal or tax advice. You should consult with your CPA and Estate Planning Attorney to determine whether the use of an Irrevocable Life Insurance Trust is appropriate for your planning needs.
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