The Benefits of an ILIT: Securing Your Financial Legacy

An Irrevocable Life Insurance Trust (ILIT) is an essential estate planning tool designed to protect life insurance proceeds and manage their distribution in a tax-efficient manner. By understanding what an ILIT is and how an ILIT works, individuals can leverage this trust to maximize the benefits of an ILIT for their loved ones. This article will explore the benefits of an ILIT, how it functions, and the steps required to establish one.

What Is an ILIT?

An ILIT is a special trust into which one places life insurance policies. Once the insurance policy is transferred into the trust, the insured no longer has any control or ownership rights in the policy; therefore the trust becomes irrevocable. Because the trust is irrevocable, the policy is not considered part of the insured's taxable estate when he or she dies. How an ILIT works is relatively straightforward: it's designed to hold life insurance policies and ensure proceeds are distributed to beneficiaries estate-tax-free.

The primary use of ILITs is for estate planning purposes whereby individuals seek to protect life insurance proceeds from potential estate tax liabilities. Other than providing a vehicle for tax-efficient wealth transfer, ILITs also afford control over the way and time the distribution of life insurance proceeds is made.

How an ILIT Works?

It is essential to recognize how an ILIT Works

To understand the benefits of an ILIT, first, it's important to recognize how it works. In establishing an ILIT, the insured either transfers an existing life insurance policy to the trust or has the trust purchase a new policy for the insured. The trust, managed by a trustee, becomes the owner of the policy.

Concomitantly, the insured pays for the policy by making annual gifts to the trust that pays the premiums. Those gifts are typically structured to fall with the annual gift tax exclusion amount in an effort to avoid any tax on the gifted amount. Upon the death of the insured, life insurance proceeds are payable to the trust and distributed by the trustee in accord with the terms of the trust instrument.

Because the ILIT is irrevocable, once the policy is placed into the ILIT, the insured cannot change the terms of the trust or regain control of the policy. As such, the policy proceeds will be protected from creditors and taxation.

Benefits of an ILIT: Crucial Points

There are 6 main benefits of an ILIT

1. Exclusion from Estate Taxes

One of the most notable benefits of an ILIT is the exclusion of life insurance proceeds from the taxable estate. This can lead to significant estate tax savings, ensuring that beneficiaries receive the maximum value from the policy. Without an ILIT, life insurance proceeds are typically included in the estate, which could trigger high tax liabilities for heirs.

2. Control Over Distribution

It is an ILIT that allows control over how and when the insurance proceeds are distributed. This makes it specifically very useful for beneficiaries who could not handle large sums of money responsibly. Under an ILIT, the terms of the trust may be tailored toward the long-term needs provision of the beneficiaries to make sure that the distributions occur over time or on specific milestones that may include completion of education or even attaining a certain age.

3. Protection from Creditors

Another important benefit of an ILIT is the protection it provides from creditors. Because the proceeds of life insurance are held in an irrevocable trust, they generally cannot be accessed by either the creditors of the insured or the beneficiaries; thus, a great deal of peace of mind is provided with regard to financial security.

4. Maintaining Eligibility for Government Benefits

In some cases, beneficiaries may be receiving government benefits that have stringent financial thresholds. A direct inheritance via a life insurance policy would disqualify them from those benefits. An ILIT can be set up to give some financial security to beneficiaries without necessarily sacrificing the beneficiaries' eligibility for government assistance.

5. Avoiding Probate

Another benefit of an ILIT is that the assets held in the trust, including life insurance proceeds, are not subject to probate. This allows for a faster and more private distribution of assets to beneficiaries, bypassing the often lengthy and public probate process.

6. Flexibility in Estate Planning

The ILIT can be designed to meet the needs and purposes of the grantor. In that sense, the estate planning may consider allowing the construction of trust to support charitable giving, take care of the family members, or to satisfy other financial goals while offering protection of long-term distribution of life insurance proceeds.

Steps to Establish an ILIT

Steps to Establish an ILIT that should be considered

Establishing an ILIT involves several key steps, all of which must be carefully executed to ensure the trust's effectiveness. Here is an outline of the steps to establish an ILIT, specially for the benefits of an ILIT:

1. Select a Trustee

First, the grantor selects a trustee-a person or entity responsible for managing the ILIT. Any trusted family member, a friend, or professional trustee can play the role of trustee. He or she will handle the administrative work of the trust, pay premiums, and make sure the proceeds of life insurance are paid in accordance with the terms of the trust.

2. Draft the Trust Agreement

Second, the trust agreement should be drafted by the client with the help of an estate-planning attorney. This is the document that prescribes the terms under which the ILIT is governed: how and to whom the life insurance proceeds are to be paid, who the beneficiaries are, what the responsibility of the trustee is. This step is important to make sure the ILIT is legally valid and meets the grantor's estate planning goals.

3. Transfer or Purchase a Life Insurance Policy

Either an already existing life insurance policy is transferred into the ILIT after its establishment or it buys a new one. This has to be done with care in order not to attract any tax implications that may arise from this transfer, such as those of gift taxes.

4. Fund the Trust

A grantor should fund the trust to provide the trustee with the wherewithal or means necessary to pay premiums on the life insurance. These funds are often made available as annual gifts to the trust, using the annual gift tax exclusion in full. Properly funding the trust will ensure that the life insurance policy remains in force.

5. Monitor and Administer the Trust

After the ILIT has been created, generally, ongoing management falls to the trustee. This typically will include paying the premiums on a timely basis, making distributions when required, and filing the required income tax returns for the trust.

Conclusion

Understanding the benefits of an ILIT is essential for those looking to protect life insurance proceeds and ensure their proper distribution. From estate tax exclusion to creditor protection, the benefits of an ILIT are numerous and impactful. By following the proper steps to establish an ILIT, individuals can ensure that their estate planning goals are met efficiently and effectively. For those looking to secure their financial legacy, One Pacific Trust provides expert trust services to guide individuals through the ILIT creation process, ensuring compliance and peace of mind.