The Irrevocable Life Insurance Trust owns the client’s life insurance. What are the advantages?
First of all, what is an Irrevocable Life Insurance Trust (“ILIT”)?
An ILIT is a type of irrevocable trust crafted during your lifetime. What makes the ILIT so unique is that it has just one job while you’re alive: own your life insurance policy. You, the insured, establish the trust. The trust document created by your estate planning attorney names the trustee (which should not be you) and the beneficiary or beneficiaries. Once the ILIT is established, you pay the amount of the insurance premium to the ILIT trustee. Then, the ILIT trustee pays the insurance company for the premium.
After your death, the ILIT can pay off tremendously. Think of an ILIT as a way to supercharge your life insurance policy. Here are the top advantages to owning your life insurance in an ILIT as opposed to owning your life insurance outright…
ADVANTAGE #1: The ILIT May Save Many Estate Tax Dollars
Most estate planning clients desire to prevent the largest amount of estate tax as legally and practicably possible. The estate planning attorney’s job is to balance the potential estate tax savings with the hassle and cost of establishing the estate plan.
This is where the ILIT shines. The ILIT is relatively easy to create and to administer, AND the ILIT has the potential to save thousands or even millions of dollars in estate taxes.
Here’s how the ILIT saves estate tax dollars. Let’s say the maximum you can give away at your death without any estate tax is $1 million. Let’s say the estate tax rate is 40% of the amount over $1 million. Let’s say that you want a $1 million life insurance policy for your child. Let’s further say you have assets (house, car, money, etc.) worth another $1 million.
In this scenario, if your life insurance policy is not in an ILIT, the federal government includes your life insurance policy in its valuation of your gross estate. Consequently, your gross estate would be valued at $2 million. This puts your gross estate $1 million over the exemption, so your estate must pay a whopping $400,000 in federal estate taxes!
Now, let’s say your life insurance IS in an ILIT… Your life insurance proceeds would not be included in your gross estate for estate tax purposes. This means that your gross estate would be valued at $1 million. Since, in this example, the estate tax exemption is $1 million, having your life insurance policy owned by the ILIT just preserved $400,000 to pass on to your child.
ADVANTAGE #2: Give the Life Insurance Proceeds to A Minor
If you have a minor child, it’s probably not wise (or even legal) to give that minor child all of the life insurance proceeds at your death. By directing your life insurance proceeds to flow to the child through the trustee of your ILIT, you now can give the life insurance proceeds to the minor child (albeit indirectly).
ADVANTAGE #3: Customize How the Beneficiary Receives the Life Insurance Proceeds
As an experienced probate attorney and estate planner, I can confidently assert that not all beneficiaries should receive large lump-sum life insurance payouts. I think of it like those lottery winners we read about. Most of those lottery winners blow through the money in no time flat, often ending up worse off than prior to hitting the jackpot.
If the life insurance policy is not owned by the ILIT, your beneficiary receives the whole payout at once. Most beneficiaries are not good stewards of large lump-sum life insurance payouts.
With the ILIT, you customize the proceeds payout. For example, you could state that the beneficiary would receive ten equal installments each year after your death. Really, there are nearly endless possibilities for the customization of the payouts. In fact, brainstorming creative distributions to the trust beneficiaries is some of the most fun we estate planners have!
ADVANTAGE #4: Divorce and Creditor Protection
If your life insurance policy is owned by an ILIT, you don’t technically own the life insurance policy. This is important even while you’re still living. See, if you get sued, your assets are up for grabs. However, if the insurance policy is owned by the ILIT, then the life insurance is not “yours.” Whether you’re going through a divorce or getting sued for some other reason, the other side can’t collect from you what isn’t even yours.
BUT WAIT, there’s more. This protection continues after your death. If the policy proceeds are held in trust after your death, the proceeds are also protected against the beneficiary’s creditors. In other words, if your beneficiary gets sued, so long as the proceeds are held in the ILIT, those proceeds are likely not eligible for collection.
ADVANTAGE #5: Generation-Skipping Tax Savings
In addition to the federal estate tax, many American estates pay the “generation skipping tax” or GST for short. An ILIT may save lots of GST dollars.
The GST applies, very generally speaking, when you give money to the generation of your grandchildren or younger. The GST is separate and in addition to the estate tax. In fact, it wasn’t so long ago that the GST tax rate was a massive 55%.
Using our scenario above, a property crafted and administered ILIT could save your beneficiaries $550,000.
It’s not ALL Rainbows and Moonbeams: Irrevocable Life Insurance Trusts Do Have Drawbacks
What’s the BIGGEST drawback to an ILIT owning your life insurance? You can’t change the beneficiaries. If you own the life insurance policy is outright, you can change the beneficiary designation all the way up until your last breath. With an ILIT, once your life insurance policy is owned by the ILIT, the ILIT’s (and, therefore, the insurance policy’s) beneficiaries are permanently locked-in.
Another drawback is the added complexity. At our estate planning law office, we default to suggesting the simplest and most elegant estate plan. Less complication is often better. Less is more. Adding the complexity of an ILIT has to be “worth it” for one of reasons listed above in this article.
To ask a legal question or get legal help from the Texas estate planning attorneys at Shutt Law Firm, use the online contact form to the right or call (214) 302-8197. If you prefer to meet at the office in person, the attorneys will gladly offer a free consultation.
Visit www.ShuttLawFirm.com for more information on basic Texas estate planning documents, a Texas ILIT, Texas irrevocable life insurance trust creation, Texas revocable trust creation, trusts for probate avoidance, and the benefits of wills vs. trusts in Texas.
Shutt Law Firm’s office is conveniently located just north of Dallas, Texas, and just South of Plano. The law office is near the intersection of highway 75 and Arapaho Road in Richardson, TX.
You can also call the estate planning attorneys at (214) 302-8197 for more information on the topic discussed in this article or to discuss a different legal matter.
Please consider the Shutt Law Firm if you want to know about the Texas estate planning, or you need Dallas Estate Planning Attorneys serving Richardson, Plano, Allen, McKinney, Garland, Addison, Rockwall, TX, Collin County, Dallas County, or surrounding North Texas area.
DISCLAIMER: Nothing in this brief article constitutes legal advice. The information provided herein is merely provided in the spirit of education and is believed to be accurate as of the time it was originally prepared, and laws change. If you have a legal question, you should consult a lawyer for your specific legal situation. Further, nothing in this article shall be construed to have started an attorney-client relationship. No such relationship exists until both you and and an attorney at Shutt Law Firm sign an engagement letter.