Many people have heard of irrevocable life insurance trusts (also know as ILIT's for short) but are uncertain about how they work and the circumstances in which they are used. The truth is that they are an extremely powerful estate planning tool for more situations than most people realize.
This is a brief introduction to ILIT's and how they work.
Many people believe that life insurance proceeds are non-taxable. In fact, they are not income taxable, but they are counted as part of your estate for estate tax purposes.
To illustrate a simple scenario in which this tool is helpful, let's look at Sam and Ellen, husband and wife, each of whom have $2M of life insurance. Because Sam and Ellen are relatively young, they may only have only done basic planning with simple wills. This life insurance may be term insurance but intended to last another 15-20 years until their children are finished with college. Or it may be permanent insurance, funded to last the owner's lifetime.
Depending on the value of their home and other assets, it is possible that as much as half of the $4M of combined insurance proceeds would be lost to estate taxes. In other words, Sam and Ellen would be paying for $4M of insurance, but getting only $2M worth of insurance.
This is where the power of irrevocable life insurance trusts comes in. If Sam and Ellen set up ILIT's to own their life insurance policies, none of the death proceeds would be subject to tax, and their children would receive the full $4M. In effect, Uncle Sam indirectly pays part of the life insurance premiums.
Much like having a regular check-up is a good idea, getting a review of your existing permanent life insurance policies is also important. It is not unusual these days to find that an existing policy is underperforming and at risk for failure.
Because of downturns in the market, assumptions made 10 years ago may be unrealistically high in today's economic environment.
Sometimes, a policy can be replaced with a less expensive policy, because the original need has changed or because actuarial assumptions have improved. Other times the the amount of life insurance may no longer be enough to cover the original purpose.
Is It Time For a Legal Check-Up?