Trusts and Estates

Irrevocable Life Insurance Trust

Reviewed by Betsy Simmons Hannibal, Attorney
An irrevocable life insurance trust can reduce your estate's tax liability by keeping the policy out of your taxable estate. However, because so few estates owe estate tax, most people don't need this kind of trust.

People usually purchase life insurance policies with the intention of providing for their loved ones after they die. However, if the value of your life insurance policy causes your estate to owe estate taxes, the benefit to your loved ones will be reduced. You can avoid estate taxes on your insurance proceeds by creating an irrevocable life insurance trust.

All of that said, most estates won’t owe federal estate tax. Federal estate tax only applies to very large estates, and each year that amount increases with inflation. The exempt amount for 2019 is $11.4 million. So most people don’t need to worry about making a life insurance trust to avoid federal estate taxes. One caveat, if you live in one of the handful of states that imposes an estate state tax on smaller estates, an irrevocable life insurance trust may make sense for you.

Your Trust Must Own the Policy

If you own your life insurance policy, the Internal Revenue Service (IRS) considers it part of your estate for estate tax purposes. It contributes to your estate's value. However, if you create an irrevocable life insurance trust, the trust can own the policy instead. To avoid estate taxes, your trust must also be the beneficiary of the policy.

You Must Give Up Control

You can set up an irrevocable life insurance trust, but your trust (not you) must own the policy. You cannot control the policy, you cannot control the trust, and you cannot be the trust’s trustee. Giving up this control is an IRS requirement for avoiding estate taxes on the proceeds. This also means that after you establish the trust, you have no right to change the trust’s beneficiaries or borrow from or against the policy. However, when you set up the trust, you can name a beneficiary for the trust funds and you can also decide how that beneficiary receives those funds. So you can determine who will get the proceeds from the policy, but you can’t change your mind.

Who Pays the Premiums?

Even though your trust owns the policy, you can still pay the premiums by transferring funds to the trustee (or anyone else) to pay the premiums. However, you’ll need to watch out for gift taxes. As of 2016, you can only make gifts of $14,000 each year to any one person or entity. If you give more than $14,000 to any one person in one year, you'll incur a gift tax on the balance. And that gift tax liability reduces the amount of your federal estate tax exemption.

If You Bought the Policy, Don’t Die for 3 Years

If you already own a life insurance policy and you want to take advantage of an irrevocable life insurance trust to shield the proceeds from estate taxes, you can transfer ownership of the policy to the trust. However, if you die within three years of the transfer, the IRS will pull the proceeds back into your estate. To avoid this look back period, the trust should be established first, then the trustee buys the policy with trust funds.

Your Beneficiaries Still Inherit

When your trust receives the death benefits from your policy at your death, it can transfer the funds to your beneficiaries just as if you had named them directly in the policy. The only difference is that the proceeds fall outside your estate, so your beneficiaries will not have to share any portion of the proceeds with the IRS.

An Estate Attorney Can Help

The law surrounding irrevocable life insurance trusts is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed information and a discussion about your individual circumstances, please contact an estate planning attorney.

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