Irrevocable Life Insurance Trust

The Basics of an Irrevocable Life Insurance Trust

DISCLAIMER: The purpose of this information is to provide general information which is subject to change and is specific to state law. ReliaQuote is not providing legal advice. If you have a specific legal issue or accounting issue, you should consult with a lawyer who is licensed to practice law in your jurisdiction or a certified public accountant familiar with tax regulations in your jurisdiction.

The irrevocable life insurance trust (ILIT) is used to shield assets, in this case life insurance, by removing the ownership and control of the policy from the estate. Life insurance is a common tool used to fund estate taxes and expenses upon the death of an individual and the transfer of a large estate. For married couples, a joint life insurance policy is commonly used because it insures both lives and pays a death benefit upon the death of the second spouse (when estate taxes will be due). In addition, the annual premium for this type of policy is often considerably less than a policy purchased on one person's life. If the life insurance policy is not removed from the estate then the proceeds of the policy will also be subject to estate taxes. 

Ideally the trust should be created before the life insurance policy is applied for. After the trust is created the trustee applies for a life insurance policy and makes the trust the owner and beneficiary. If a life insurance policy is already in existence before the trust is created, then the policy should be gifted into the trust by the policyowner. This is done by changing the owner and beneficiary of the policy to the trust. If a life insurance policy is transferred into a trust that was created after the policy was issued then the transfer is subject to the three-year rule. The three-year rule states that if a death benefit is paid within three years of the transfer then the proceeds will be included in the grantors estate and thereby subject to estate taxes.

The premiums for the life insurance policy in an irrevocable trust are paid for by the trustee with gifts made to the trust by the grantor and spouse. The trustee administers the trust and any distributions. Upon the death of the second spouse, a joint life insurance policy (otherwise known as a second-to-die policy) will pay a death benefit to the trust. The trustee will then distribute the life insurance proceeds according to the terms of the trust document. This type of arrangement is valuable because it can provide the liquidity and income to pay the estate taxes and expenses immediately so that the estate can remain intact when passed to the heirs.