Life insurance often is a critical part of a properly structured estate plan. There are three primary purposes for purchasing life insurance. First, it may be acquired to replace lost income, if there is a premature death of a wage earner. Second, it may be acquired to provide liquidity to pay estate taxes (or replace funds used to pay estate taxes), often upon the death of the last to die of a married couple. Lastly, it may be acquired as an investment asset, in that the earnings can accumulate to increase the policy’s cash value on an income tax-free basis.
Life insurance, however, is an asset like any other asset—if the insured owns or “controls” the policy as of date of death—the full amount of the policy proceeds will be includible in the insured’s estate for estate tax purposes. This result can be avoided, however, by having someone other than the insured own the insurance and receive the insurance proceeds. This is often accomplished through the use of an irrevocable life insurance trust (“ILIT”).
What is an ILIT?
The ownership of insurance policies also can be given to the insured’s children to avoid estate tax inclusion in the insured’s estate. The problems with this solution, however, are two-fold. First, where the insurance is on the life of the wage-earner, it is often the family’s desire that the surviving spouse have access to the insurance proceeds or the income generated by the proceeds. Second, even where survivorship insurance is involved, the insureds often do not want the children to be in the position to spend the proceeds immediately upon the death of the insureds. The solution to both these common scenarios is the ILIT.
An ILIT is created by the insured(s). This trust is irrevocable and becomes both the owner and beneficiary of the insurance. As such, the trust cannot be changed by the insured and, if properly structured, the proceeds of insurance will not be included in the estate of the insured(s).
Where the insurance is on the life of the wage-earner, the surviving spouse can be the trustee of the ILIT and, generally, can be entitled to all the income of the trust and principal, if needed for reasonable living needs, as determined by the surviving spouse. Notwithstanding all these rights, upon the death of the surviving spouse the assets of the trust are not subject to estate tax in that spouse’s estate. And upon the spouse’s death, the assets of the trust can then be held for the benefit of the children (or other heirs) or distributed outright to them without imposition of estate tax.
How Does An ILIT Mechanically Operate Year After Year?
Estate Tax Savings of Transferring Insurance Ownership
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© 2008 Levun, Goodman & Cohen, LLP