The ILIT, or Irrevocable Life Insurance Trust (pronounced eye-lit), is a financial strategy that can help transfer significant wealth to heirs while avoiding income, estate, and inheritance taxes and sheltering assets from creditors. If you are (or intend to become) wealthy and you wish to transfer significant sums to your heirs in a tax-efficient manner, then the following information could serve as an important first step.
By combining the best traits of life insurance, the tax efficiency of the irrevocable trust, and the means to share wealth with heirs, the ILIT can multiply family wealth significantly.
Here’s how it works:
First, the death benefit payment of a life insurance policy is normally income-tax-free, even though the premiums paid were less than the face amount of the policy. The “gain” on this policy is thus income-tax-free, as are many death benefit claims from life insurance.
Generally, assets under your control when you die are includable in your taxable estate. If you’re in a situation where you have over $10 million in your estate ($20 million if you are married), your estate assets over this amount can be taxed at 40 percent by the federal government. Inheritance tax is different in each state. The proceeds of a life insurance policy that you own at your death will probably be included in your estate and could be subject to that tax.
However, assets held in a trust that cannot be changed by you (called an irrevocable trust) are generally not included in your estate as long as certain conditions are met. Therefore, with the help of your estate-planning lawyer, you can create an irrevocable trust that is designed to own insurance on your life. The proceeds of that life insurance—payable to the trust, which pays the death benefit payment to your heirs—are not included in your taxable estate.
Drafted properly and funded with gifts or cash transfers that meet specific criteria, the payment from the insurance benefit through the ILIT can be income-tax-free as well as estate- and inheritance-tax-free.
In addition to favorable tax treatment, transferring wealth to heirs with life insurance is relatively effortless for the recipients. There are no auctions, no sales of property, no valuations, and the transfer generally is not subject to probate.
NOTE: Seek advice and counsel from qualified professionals and learn the risks and benefits of creating an ILIT based on your unique family and financial circumstances. The passage above is for informational purposes only and should not be used for the purchase or sale of insurance-based products without the prior consultation of a qualified and licensed insurance professional.