How Can an Irrevocable Life Insurance Trust (ILIT) Protect Your Family’s Assets?

When you are crafting your estate plan, there are multiple tools that you can use to maximize your family’s wealth. One of those is an Irrevocable Life Insurance Trust (ILIT). Life insurance can be a powerful estate planning tool, and the ILIT offers many advantages that harness this power, including estate tax reductions, asset protection, and plenty of control over how your life insurance proceeds are distributed to beneficiaries. However, as with most factors in estate planning, it is important to be aware of how best to utilize this tool as part of a comprehensive and strategic estate plan. An experienced Naperville, IL estate planning attorney can help you incorporate an ILIT into your estate plan. 

What is an Irrevocable Life Insurance Trust?

An ILIT is a trust created during your lifetime that can hold your life insurance policy (or multiple life insurance policies) and distribute the proceeds from those policies to beneficiaries upon your death, according to your instructions. An ILIT can help you manage your life insurance assets and benefits, and it offers some significant advantages over keeping the life insurance outside a trust.

How Does an ILIT Work?

When you create an ILIT, you put your life insurance policy into the trust. This places ownership of the life insurance in the hands of the trust rather than in your hands, which, as we will see, has beneficial legal significance. 

You can put a new or existing life insurance policy into an ILIT. So long as an existing policy is in place for three years after it is transferred into the ILIT it will not be subject to estate taxes. You may also use your annual gift tax exclusion to fund the ILIT.

When you create the trust you will specify how the proceeds of the life insurance policy will be distributed and managed. For example, you could specify that they are meant to make income for the trust or should be distributed to certain beneficiaries. The trustee manages trust payments to beneficiaries and pays the insurance policy premiums with trust assets. 

As an irrevocable trust, the ILIT cannot be changed in any way once it is created, so once you create and fund this trust, you cannot terminate it. 

What Is the Process of Setting Up an ILIT?

To set up an ILIT, you will select a trustworthy trustee. This can be a professional trust company, a family member, or a friend. The next step is to draft the trust document outlining the terms of the trust, including who the beneficiaries are, how you wish the funds to be distributed, and what powers the trustee will have. This is where a knowledgeable estate planning attorney can be especially helpful, working with you to set up your ILIT in a way that ensures you are legally protected and that you benefit from its asset preservation elements. Next, you will transfer the life insurance policy (or policies) to the ILIT. As a final step, you must ensure that the ILIT contains enough liquid funds to pay any life insurance premiums and other expenses that may come up.

How Can an ILIT Help Protect Your Family’s Wealth? 

ILITs have many benefits for asset preservation if structured properly:

Taxes

Notably, this type of trust protects proceeds from your life insurance policy from being subject to estate taxes. This is due to the fact that, as mentioned above, it is your trust, not you, that has ownership over the life insurance policy. As a result, the payout from life insurance goes to the trust upon your death rather than to the estate. In this way, the proceeds from the life insurance policy will not be included in the estate, and this significantly reduces estate tax liability. 

Privacy 

Because the life insurance policy is placed into a trust, any proceeds from that life insurance and the details of it will not go through probate. This is relevant for privacy because probate records are public information. By preserving privacy, ILITs ensure that your family’s reputation is not affected by any estate planning decisions.

Asset Protection

ILITs protect life insurance proceeds from creditors. Since they are irrevocable trusts, once you set up the trust you legally do not own the underlying assets that funded the trust–in this case the life insurance proceeds. Since you do not own the trust assets, creditors cannot go after them to recover debts. This is one key way in which ILITs preserve your family’s assets.

Spendthrift Protection

By allowing you to control the distribution of funds over time, rather than giving the entire life insurance proceeds to your beneficiaries in one go, ILITs provide you with what is called “spendthrift protection.” They protect beneficiaries who may not be financially responsible or may not know how to handle a large sum of money by keeping them from spending it all at once or irresponsibly. In this way, the trust protects your family financially and protects your wishes regarding how the money will be used.

Are There Any Drawbacks to ILITs?

As with most things in estate planning and life, there are a few drawbacks to ILITs. The main one is the inability to change or terminate it, as it is an irrevocable trust. However, any potential issues that could arise given this lack of flexibility can be mitigated with careful estate planning and management. ILITs can also be challenging to administer, but again, this is something that a qualified estate planning attorney can overcome. 

What About Revocable Life Insurance Trusts?

It is also possible to set up a revocable life insurance trust. While this may be a good idea when you know you may have to make changes to the trust, you lose out on many of the benefits of an ILIT, including tax benefits and protection from creditors. 

Call a Naperville, IL Estate Planning Attorney 

Whether you are just starting out on your estate planning journey or want to make adjustments to your estate plan, knowledgeable and professional legal representation is essential. If you are wondering whether an ILIT is a good fit for your estate plan, an experienced Naperville, IL estate planning lawyer at the Gierach Law Firm can answer your questions and help maximize your family’s wealth. Call our office at 630-756-1160 to schedule your initial consultation.