By establishing an ILIT and paying policy benefits directly into an Irrevocable Trust, beneficiaries are shielded from the income and estate taxes that come from directly receiving proceeds from Life Insurance policies.
Without an ILIT, any benefits that an insurance policy pays out are subject to estate tax, and ultimately reduce the total amount of money that beneficiaries of a policy receive.
How To Create An Irrevocable Life Insurance Trust
In order to create an ILIT, you must establish an Irrevocable Trust, typically with the trustee being your spouse or children and the beneficiaries of the trust being your spouse or children. The insurance policy is then transferred to the Trustee of trust, meaning that you no longer own the policy and thus can no longer count any future payouts from the policy among your assets.
The ILIT is named as the beneficiary of your life insurance policy, so that when you die, the payout will go directly into the ILIT and will not have to go through probate. This way, the beneficiaries of the trust can receive the benefits of the life insurance policy without having to pay income or estate taxes.
There are many moving parts and small things to pay attention to when setting up an ILIT, but it can be hugely beneficial to your family. If you want to set up an ILIT but you're feeling overwhelmed by the idea of figuring all this out on your own, you might want to contact a local trust and estate attorney who can help you make these arrangements.
When a Life Insurance policy is held in an ILIT, the simplest way to pay premiums is to fund the trust, and have the trust pay the premiums. You can transfer money to the trust, and then the trustee of the trust can write checks from the dedicated bank account associated with the trust to pay the insurance premiums.
Taxes On Funds Transferred Into The Trust
You may transfer up to $14,000 per year into the ILIT, tax-free. This is because $14,000 is the annual gift tax exclusion for 2013. If you transfer more than $14,000 into the trust in a given year, the transferred amount over $14,000 will be subject to federal gift tax.
Be Aware Of Bank Fees
The sole purpose of the insurance trust bank account is to pay the premiums on the insurance policy. Many banks have standard monthly or annual fees based on the minimum balance in the bank account, as a basic charge for having the account, or for other reasons. Be aware of these fees and any changes to the fees on the account. If the account goes into overdraft, which can often happen with unannounced fee changes, the account will be blocked, and any attempt to pay insurance premiums will be prevented. This can be highly dangerous, as any lapse in payment of insurance premiums may result in an automatic cancelation of those policies and a forfeiting of all funds that had been put into the policy.
To avoid this type of situation, try to find a bank account where you can put in a minimum balance that eliminates all fees. If you can't do that, be aware of monthly fees that may chew through any funds in the account and lead to insurance policies becoming invalidated.
To learn about setting up trusts, see Establish Trusts.