Contact:
Alison Arden Besunder
212-695-8100, ext. 289
[email protected]
What Is a Life Insurance Trust & How Does It Work?
In short, an Irrevocable Life Insurance Trust (or ILIT):
- Protects your life insurance payment from being countable in your gross estate.
- Protects the proceeds of life insurance from creditors and predators of your beneficiaries.
- Gives you more control over how the proceeds of your life insurance will be used after your death.
Many people have the incorrect impression that life insurance is “tax free.”
It is true that life insurance is income tax free, however, life insurance left to anyone other than a spouse is not exempt from estate tax.
How does an ILIT save estate taxes?
An ILIT is an estate tax savings device. The irrevocable trust owns the life insurance policies on the life of the grantor and has complete control over the policies. The policies are transferred to the trust, or the trust purchases new life insurance on the life of the grantor. Occasionally, income-producing assets are placed in the trust to pay the premiums.
Alternatively, with “whole” life insurance, the income generated by the whole life insurance policy is sufficient to pay future premiums. Another possibility is for the grantor to make annual gifts to the ILIT. Since you do not personally own the insurance policies, you do not have an “incidence of ownership” and the policies will not be included in your estate – your estate taxes, in turn, will be reduced.
The grantor, who is usually also the insured, surrenders all ownership interest and control in the policies. When the grantor dies, the trust collects the insurance proceeds free of estate tax. Since the insurance is not payable to the estate, and the grantor did not “own” the policies at the time of his or her death and relinquished all rights in the policies, the proceeds of the life insurance policy are paid free of estate and income tax.
Why do I need an ILIT if the federal exemption is $12.92 million, and there is portability between spouses?
The law can change at any time and the exemption may be reduced. New York State increased the exemption to $6.58 million but also increasing the risk that your entire estate could be subject to the tax if it is in excess of 5% over the exemption amount. Your gross estate may also increase substantially by the time you die.
Can I be my own trustee?
If your objective is to save estate taxes, you may not be your own trustee. Sometimes people name their spouse or other individuals as trustee or co-trustees. However, it is important to recognize that many people do not have the time, experience, or understanding necessary to fulfill the fiduciary obligations of a trustee. Sometimes people choose a corporate trustee (a bank or trust company) who can make sure that the trust is properly administered and the insurance premiums promptly paid.
A trust sounds complicated. Can I name someone else as the owner of my insurance policy? Why can’t I just name the nominated guardian of my kids?
If someone else such as your spouse owns your policy at your death and dies first, the cash/termination value (of a whole policy) will be in his or her taxable estate, which doesn’t solve the problem. If you and your spouse switch ownership of each other’s policies, and you both die in a simultaneous disaster, then both policies will be taxed.
More importantly, if someone else owns the policy, you have no control over those assets or how they are used. They will be taxable in that person’s estate and subject to that person’s creditors and predators, including their spouse if he or she becomes divorced. This person could change the beneficiary, take out the cash value, or even cancel the policy and leave you without any insurance. If you pick a trustee with whom you are on good terms at the time you choose them but later have a falling out, this could very well happen. You may trust the person now, but have problems later on.
An ILIT allows you reduce estate taxes while still keeping some level of control.
Goetz Fitzpatrick LLP has been offering clients insightful solutions throughout the New York Metropolitan area since 1967. The firm provides its clients with expertise in the areas of Construction and Real Estate, Trusts & Estates Administration & Litigation, Commercial Litigation, Corporate, Bankruptcy, and Labor & Employment. The firm’s office is located at One Penn Plaza, Suite 3100, New York, NY 10119, Telephone 212 695 8100, [email protected], www.goetzfitz.com. You can learn more about Goetz Fitzpatrick on: LinkedIn | X (Twitter) | Soundcloud | YouTube | Facebook | Instagram
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