A Life Insurance Trust is a trust designed to own life insurance, typically being irrevocable. This type of trust is sometimes referred to as an Irrevocable Life Insurance Trust, or “ILIT.” This type of trust is used to manage and distribute life insurance proceeds per the trust terms and the grantor’s intent. Life Insurance Trusts serve multiple purposes, including maximizing use of the annual gift tax exemption to reduce the size of a grantor’s taxable estate over time, asset protection, control over distribution, safeguarding government benefits, and efficient wealth transfer across generations.

Benefits of Irrevocable Life Insurance Trusts

• Provide Liquidity: Life Insurance Trusts can be used to provide readily accessible funds to cover immediate estate expenses, such as taxes and administrative costs, which can be essential when many estate assets are illiquid.
• Minimize Estate Tax Liability: By making the trust the beneficiary of the policy, the trust can be structured to prevent insurance proceeds from being part of the grantor’s taxable estate, minimizing federal estate tax liability.
• Maximize Annual Gift Tax Exemption: Life Insurance Trusts can be used to enable grantors to maximize annual gift tax exclusions, reducing their taxable estate over time.
• Maintain Government Benefits: These trusts can be used to safeguard government benefit eligibility for beneficiaries receiving assistance, like Social Security disability income or Medicaid.
• Generation-Skipping Transfer Tax (GST) Planning: Life Insurance Trusts can be used facilitate the use of annual gifts to fund premiums, ensuring multiple generations benefit from trust assets without GST tax.
• Distribution Control: Grantors can specify how insurance proceeds are distributed, granting discretionary powers to trustees for various purposes.
• Creditor Protection: Properly drafted Life Insurance Trusts can protect insurance policy assets from grantor and beneficiary creditors, depending on state laws.

Important Considerations when Establishing Irrevocable Life Insurance Trusts

• Maximizing Gift Tax Exclusions: Proper administration and Crummey letters (notifying beneficiaries of withdrawal rights) are crucial for utilizing gift tax exclusions.
• Gifting Existing Policies to a Trust: Transferring existing policies to a Life Insurance Trust has a three-year lookback period for estate inclusion and potential gift tax implications.
• Choosing the Right Trustee: Select a trustee capable of managing premiums, legal responsibilities, tax filings, and notices, often a professional or corporate trustee.
• Funded vs. Unfunded Life Insurance Trusts: Trusts can be funded (own both policy and income-earning assets) or unfunded (grantor contributes annually to cover premiums). Funded trusts may trigger gift and income taxes, whereas unfunded ones leverage annual gift tax exclusions to cover premiums.
• Deciding Trust Jurisdiction: The trust’s domicile should consider insurance premium tax, state income tax, and asset protection laws, with trust situs usually based on trustee location and specific state requirements.

Note: The information provided here is for general educational and informational purposes only. It is not legal advice and should not be interpreted as such. For a thorough understanding of these topics relevant to your specific circumstances, we recommend consulting a qualified estate planning attorney. Peak Trust Company cannot provide legal advice; however, we can serve as an informational resource and provide referrals to highly skilled attorneys who can offer legal and tax guidance tailored to your specific needs.