Six reasons clients should consider irrevocable life insurance trusts

An irrevocable life insurance trust (ILIT) is a valuable tool in estate planning, especially with the estate and gift tax exemptions set to sunset in 2026. Absent legislative intervention, lifetime gifting exemptions are set to fall from $13.61M to about $7M. Clients, particularly high-net-worth individuals, may benefit from establishing an ILIT now to take advantage of current gifting exemptions and remove assets from their taxable estate.

To learn more about ILITs, download our whitepaper.

What is an ILIT?

An ILIT is an irrevocable trust created by a grantor to manage a life insurance policy, aiming to reduce estate taxes and safeguard assets while facilitating controlled wealth distribution to beneficiaries. By relinquishing control over trust assets, the grantor ensures the efficient transfer of insurance proceeds to designated heirs per the trust's terms.

Benefits of ILITs include:

1. Minimizing estate taxes: ILITs effectively reduce an individual's taxable estate by transferring asset ownership, including life insurance, to the trust while the grantor cedes control. Consequently, assets held within the ILIT are excluded from the individual's estate for tax purposes, ensuring that the life insurance policy doesn't inflate the estate's overall value. 
2. Minimizing gift taxes: Establishing an ILIT allows individuals to contribute annually to cover life insurance premiums without triggering gift taxes, as long as they stay within the allowable gift tax exclusion amounts, which in 2024 are $18,000 per individual or $36,000 for married couples. For gifts exceeding the annual exclusion, individuals can apply them to the applicable lifetime exemption, currently at $13,610,000 per individual in 2024. 
3. Maintaining eligibility for government benefits: ILITs typically don't affect individuals' eligibility for government benefits like Social Security or Medicaid since the trust structure removes assets from direct ownership and control. For special needs individuals, an ILIT, specifically a Special Needs Trust, can ensure they can still receive necessary government assistance while benefiting from the trust's assets.
4. Asset protection: The grantor relinquishing control over assets in the ILIT can shield them from creditor claims. Additionally, while states protect life insurance death benefits from creditors, some allow cash value claims; an ILIT secures proceeds for beneficiaries, protecting them from potential legal actions or financial liabilities against the grantor.
5. Control over wealth distribution with incentive clauses: ILITs incorporate incentive clauses enabling grantors to steer beneficiary behavior by setting conditions for receiving distributions from life insurance proceeds, such as milestones like graduation, home purchase, or marriage. Failure to meet these conditions could result in beneficiaries being ineligible for some or all trust assets.
6. Legacy planning: Legacy planning often grapples with the generation-skipping transfer tax (GSTT) levied on assets passed to beneficiaries two or more generations below the grantor. Utilizing ILITs, particularly dynasty trusts, individuals can allocate funds toward the GSTT exemption, currently set at $13.61M, coupled with the lifetime gift exemption to mitigate potential gift tax.

Types of ILITs

• Spousal lifetime access trust (SLAT): Grants the spouse access to income while keeping assets outside the taxable estate.

• Special needs trust: Tailored for individuals with disabilities, ensuring their standard of living while safeguarding government assistance eligibility.

• Dynasty trust: A long-term trust designed to provide financial benefits for multiple generations of a family. 

Risks and considerations 

While ILITs offer significant advantages, such as tax benefits and asset protection, their irrevocable nature can be a downside, limiting the ability to make changes if circumstances shift. Additionally, selecting a trustee is crucial, as they are legally obligated to manage the trust responsibly, and opting for an inexperienced or unreliable trustee could jeopardize the trust's effectiveness and invite potential lawsuits from beneficiaries.

Grantor vs. non-grantor tax obligations

Grantor trusts entail the grantor bearing income tax responsibility for trust income, fostering asset growth outside the taxable estate. In contrast, non-grantor trusts are subject to taxation on earned income, with potential downsides, including reaching the maximum tax bracket of 37% with just $14,450 of income in 2024.

Next steps

If your clients are considering establishing an ILIT, they’ll need to find the right life insurance product. A tech-enabled brokerage like Modern Life can help make the process as streamlined as possible. To learn more, schedule a demo.