Long considered a necessity by the insurance industry, the Irrevocable Life Insurance Trust (ILIT) is one of the best estate planning tools. An ILIT combines the leverage inherent in a whole life insurance policy, with the nuances of estate planning. The basic idea is quite simple. An Irrevocable Trust is established by an individual or couple (the grantor or grantors). The trust document names the children or grandchildren of the grantor(s) as the beneficiaries. The trust then purchases a permanent insurance policy on the life of the individual or couple (survivorship life insurance). The insurance is funded through annual gifting to the trust in the amount of the insurance premium.
Funding the insurance policy through annual gifting, allows the grantor(s) to take advantage of the annual gift tax exemption of $14,000 per beneficiary. When structured correctly, these gifts will pass to the beneficiaries completely gift tax free. As an example, suppose an individual has five children. He or she could potentially fund the ILIT with as much as $70,000 ($14,000 x 5) per year. This could fund a significant amount of permanent life insurance. Depending on the type of insurance and the age of the grantor, somewhere between 3 and 7 million dollars of insurance would be within reason. As the trust is not within the taxable estate of the grantor, the full value of this insurance creates an “instant estate” that escapes estate and gift taxation.
Another advantage of this structure relates to income taxation. As life insurance grows without current income taxation, and the death benefits are also income tax exempt, the assets transferred to this trust will no longer be subjected to income taxation. The combined effect of no income, gift or estate tax makes the ILIT extremely attractive as an estate planning tool.