An irrevocable life insurance trust (ILIT) is a trust that serves as the owner and beneficiary of a life insurance policy. A life insurance trust helps wealthy individuals to protect assets and avoid estate taxes, and is a succession planning tool for small business owners who want to transfer a business to heirs or partners.
Small business owners who want to use a life insurance trust as part of their succession plan can do so by working through a life insurance company. AXA Equitable, a prominent life insurance company in this marketplace, is the sponsor of this article. You can learn more about AXA Equitable’s offerings by visiting their website.
How an Irrevocable Life Insurance Trust Works
An ILIT is a trust set up specifically to own life insurance policies on a person – typically a wealthy individual or business owner. One of the key features of this type of life insurance trust is that it’s irrevocable, meaning once established, it can’t be amended or broken except with the consent of the beneficiaries, or possibly by court order.
One of the primary reasons for using an ILIT is reducing estate tax liability. In an irrevocable life insurance trust this is accomplished by having your trust own and serve as beneficiary for your life insurance policy. When the insured person dies, the proceeds of the insurance policy stay in the trust, thereby keeping the proceeds out of the taxable estate.
Understanding what is an ILIT and how it works can make this a valuable tool for succession planning to protect assets, transfer large amounts of wealth to heirs, and avoid estate taxes. In a business, ILITs can also provide funds for heirs or partners to purchase a business from the business owner’s estate or to provide financially for other family-members who aren’t involved in the business.
When to Use an Irrevocable Life Insurance Trust
A life insurance trust is ideal for family business owners or wealthy individuals who have large or complex holdings. Using an irrevocable life insurance trust, you can shield heirs from estate tax and decide how you want to pass along control of your estate, including ownership of any closely-held businesses.
Life insurance trusts can also be extremely beneficial for business owners who have multiple heirs, only some of whom will be taking over control of the business. In these cases, a life insurance trust can provide for heirs who aren’t involved in the business while allowing those heirs who are involved to assume control and ownership.
Irrevocable life insurance trusts can be especially helpful for:
- Family Business Owners – An ILIT can help heirs to buy a business from the previous generation’s estate
- Majority Partners – In partnerships, a life insurance trust can allow remaining partners to buy their share
- Closely-Held Business Investors – Insurance can help plan and manage the transition of ownership
- Wealthy Investors – People with many business interests can use an ILIT to coordinate the transfer of their assets
When to Use an Irrevocable Life Insurance Trust for Succession Planning
There are three main reasons to use an irrevocable life insurance trust for succession planning – to protect assets, avoid estate taxes, or leave substantial assets to a minor. In each of these instances an ILIT reduces your taxable estate, protect assets from creditors, and make sure that trust proceeds are managed properly for future generations.
The three reasons small business owners use an irrevocable life insurance trust for succession are:
1. Estate Tax Avoidance
Whenever an American dies, their estate is subject to estate tax of up to 40%. However, most people don’t pay estate tax because the first $11.18 million of an estate ($22.36 million for married couples) are excluded from federal estate tax. ILITs can be used by individuals whose estates exceed the exclusion and are taxable. Estate taxes are reported on IRS Form 706 and are subject to the rates in the table below.
United States Estate Tax Rates 2018
|$0 - $10,000|
|$10,000 - $20,000|
|$20,000 - $40,000|
|$40,000 - $60,000|
|$60,000 - $80,000|
|$80,000 - $100,000|
|$100,000 - $150,000|
|$150,000 - $250,000|
|$250,000 - $500,000|
|$500,000 - $750,000|
|$750,000 - $1 million|
The way an irrevocable life insurance trust is structured, the proceeds of life insurance policies held within the trust are excluded from the value of your estate. If you transfer a policy you currently own to an ILIT, proceeds will be excluded so long as you don’t die within three years of transferring the policy. Because these proceeds are excluded from your estate, they aren’t included as part of the taxable value of your estate, nor do they use part of your exclusion.
“With passage of the Tax Cuts and Jobs Act in 2017, the federal estate tax exemption for 2018 is $11.18 million per individual ($22.36 million for a married couple). Any estate above exemption amount would be subject to estate tax. In addition, note there are several individual states that have some version of their own estate or inheritance tax and exemption thresholds. A wrinkle to proper planning is that the exemption amounts are scheduled to sunset and revert back to 2017 levels (Appx $5.6 million) after 2025. Proper planning requires an in-depth discussion with an experienced estate planning attorney – and carefully setting the framework for an ILIT that will meet overall objectives and overcome numerous hurdles such as an estate tax in a flux.”
– Alex Kim, AVP of Advanced Markets, AXA.
2. Leaving Wealth to a Minor
Many wealthy individuals worry about leaving money to a minor – that they may not be mature enough for it or act responsibly with their inheritance. An irrevocable life insurance trust resolves those worries by placing restrictions on life insurance proceeds held in trust until the minor reaches a certain age.
Transferring wealth to a minor is a particular concern for small business owners. However, an ILIT can help with the transfer of wealth to a minor by ensuring that they’re given proper guidance on how to manage assets properly in addition to placing restrictions on an inheritance until they’re ready.
3. Asset Protection
In today’s litigious society, it’s important to protect assets from creditors. Using trusts has been one way of shielding assets for a long time. In addition to the estate tax, an irrevocable life insurance trust can help to protect an estate from creditors or other claims.
Using an irrevocable life insurance trust for succession planning can be especially beneficial for owners of high-liability businesses or wealthy individuals concerned about possible future legal issues. Shifting a portion of their estate to an ILIT, you may be able to effectively insulate those assets against claims from creditors.
Irrevocable Life Insurance Trust Costs
Irrevocable life insurance trusts typically cost several thousand dollars to establish and $1,500+ per year to administer. In addition to the premiums for the insurance policy held by the trust, there are also fees for a lawyer to setup and administer the trust. Trusts are also reviewed periodically to make sure no changes are necessary.
“The cost of drafting an irrevocable life insurance trust is driven by many factors, but $1,000 is a good minimum budget for a barebones document. A reasonable starting cost for annual administration of the trust is $400 – $500, but this is largely driven by trustee selection. The type of policy used in an ILIT also impacts the legal fees for drafting the document. For example, if the client uses a term policy and later changes their mind about their policy, this can impact their costs.”
– James Aussem, President, Society for Financial Service Professionals
Typical costs of a life insurance trust include:
- Trust Drafting Fee: $1000+
The costs of hiring an estate planning attorney to draft a trust document
- Trust Administration: $400+ annually
ILIT trusts are often administered by an attorney to maintain their independence from grantors
- Life Insurance Premiums: $80+ monthly
There are monthly life insurance costs for the life insurance held within a life insurance trust that typically start at $50/month for a $500,000 – $1,000,000 policy
For most small business owners, the cost of setting up an ILIT and covering the premiums of permanent life insurance could be significantly higher than outlined above. For example, the costs associated with a life insurance trust will vary based on location and those living in areas with higher costs of living should expect higher costs. Similarly, life insurance premiums will increase with the insured individual’s age, health conditions, and type of life insurance selected.
Irrevocable Life Insurance Trust Rules
If you want to use an irrevocable life insurance trust, you have to follow certain rules that govern the trust’s formation and administration and establish the trust’s independence from the grantor (person who established the trust). These rules help ensure that there are no unforeseen tax consequences and your ILIT will help succession planning.
The five primary irrevocable life insurance trust rules include:
1. Proper Formation of the Trust
The first requirement to establish an irrevocable life insurance trust is to set up the trust that will hold your estate planning life insurance policy.
Your trust needs to be set up in the correct state and include certain provisions. For this reason, it’s best to work with an attorney who specializes in trusts and estate planning – otherwise your trust may be broken later on or your life insurance proceeds could be subject to estate taxes.
2. Trust Must Own the Insurance Policy
To set up your life insurance trust correctly you need to make sure that your trust is the owner and beneficiary of your life insurance policy. If you own the policy directly or include beneficiaries on your policy other than the trust itself, your trust may not serve its intended purpose.
3. Pay Premiums with Crummey Gifts to the ILIT
In an ILIT all life insurance policy premiums need to be paid by or through your trust. This is typically done by making “crummey gifts” to the trust which are used to pay premiums.
Whenever a gift is made to the trust, the trustee must send a letter to the beneficiaries informing them that a gift was made to the trust.
The use of crummey gifts is relatively straightforward. However, if you make premium payments directly to your life insurance company, this can call into question the independence of the trust and potentially affect your estate plan.
4. Trust Must be the Beneficiary of the Life Insurance
In order to be used to aid in your succession planning and avoid estate tax, your ILIT needs to be the beneficiary of your estate planning life insurance policy, in addition to being the owner of the policy. Naming beneficiaries aside from the trust can cause you to lose control of how those proceeds are managed later on. Depending on the size of your estate, proceeds may also be subject to estate tax.
5. Trust Must Remain Unbroken and Unamended
One of the defining points of what is an ILIT is that your trust needs to be irrevocable. This means that once your trust is formed it can’t be broken or amended. If you retain the power to amend your trust or revoke it, this can lead to your heirs having to pay estate tax.
“Some common mistakes include transfer of an existing life insurance policy to an ILIT. If the grantor/insured dies within three years of making the transfer, the proceeds will be subject to estate tax. There are also gift tax considerations for the necessary annual premiums for the life insurance policy. This can generally be avoided so long as the trustee of the ILIT sends out annual “Crummey” letters to the beneficiaries regarding their right to exercise their withdrawal powers. In effect, the grantor of the ILIT can shelter an amount equal to the annual gift tax exclusion for each trust beneficiary. However, some trustees have failed to send out the annual letters, jeopardizing the client’s estate and gift tax planning.”
– Alex Kim, AVP of Advanced Markets, AXA
How to Set Up an Irrevocable Life Insurance Trust
Setting up an ILIT generally involves two different groups – an estate planning attorney and a life insurance company. The first step for setting up an irrevocable life insurance trust involves drafting your trust with an attorney. Once you’ve set up your trust, it’s best to work with an established life insurance company to purchase a policy.
The two parties you must work with to set up your irrevocable life insurance trust are:
1. Estate Planning Attorney
If you have an estate large enough that you would benefit from using an irrevocable life insurance trust, it’s important to work a licensed attorney who specializes in estate planning. Getting in touch with someone who can get your trust properly established is the first step in setting up an ILIT.
To find a good estate and trust attorney, start with any law firms that you already have a relationship with. If they don’t have a good estate planning attorney in-house, they may be able to recommend a reputable local firm. If you still don’t have any luck, you can always check with your local bar association or use an online directory to find good legal counsel.
2. Life Insurance Company
When looking for a provider for life insurance policies to go in your insurance trust, it’s best to look for a large, established firm with a long history of providing reliable life insurance. If your estate is large enough to benefit from an ILIT, you certainly don’t want to work with a small or disreputable insurer.
One example is AXA Equitable, which is a large provider of many financial planning products including brokerage accounts, retirement plans, and life insurance. Among life insurance products AXA Equitable and its affiliate, MONY Life Insurance Company of America (MLOA), offer whole-life, term-, and universal life insurance policies that many clients use as part of ILITs.
Setting Up an Irrevocable Life Insurance Trust in 4 Steps
Setting up an ILIT can be somewhat time-consuming because you’ll need to work with both the attorney and the life insurance company before it’s ready to go. It’s important to understand the steps and how each works with you so that your trust gets set up correctly. Following the right steps will leave you with an unbreakable life insurance trust that can’t be contested later.
The four steps to set up an irrevocable life insurance trust for succession planning are:
1. Draft the Irrevocable Life Insurance Trust
The first thing to do if you want to use a life insurance trust is to create the trust that will hold your life insurance policy. You should work with a licensed attorney who is an expert in trusts and estates. If you plan to use your irrevocable life insurance trust to help with succession planning, the trust should be structured to meet your specific needs and objectives.
2. Pick a Life Insurance Company
Once you have a trust that can hold your life insurance, you need to identify an insurance company to work with. When you’re trying to identify a life insurance company, you want to work with an established, reputable firm that has a long history of helping clients meet their individual insurance needs.
When looking for established insurance companies, there are few with longer histories than AXA Equitable. AXA Equitable was started over 200 years ago and is one of the largest insurance companies in the world, providing a host of life insurance products including term-, whole-, and universal life policies. Any or all of these can be used to help with succession planning or other needs.
3. Decide on a Life Insurance Policy
After your trust is set up and you’ve selected an insurance provider, you need to work with a representative from your life insurance company to pick a policy that’s best for you. Life insurance comes in all shapes and sizes, so it’s up to you to choose what kind of policy works best for you. AXA Advisors, for example, has more than 5,000 advisors nationwide and is well-positioned to help you pick the ideal policy.
4. Pay Insurance Premiums Through the ILIT
The final step to setting up and administering your irrevocable life insurance trust is to make sure you pay all premiums and other costs for your life insurance through the trust – not directly. Paying premiums directly from your own account or naming beneficiaries of the insurance other than the trust can potentially call into question the independence of the trust or impact your succession plans later on.
Types of Insurance Used in an ILIT
There are three types of life insurance that can be included in an irrevocable life insurance trust. Whole-, Universal-, or Term Life Insurance all help avoid estate taxes, protect assets, transfer wealth, or sell business interests to heirs or partners. Which one is right for you depends on individual preference and pricing.
Whole Life Insurance in an ILIT
Whole life is a type of insurance often used in irrevocable life insurance trusts. Whole life policies have set face values and premiums that are paid by your trust. Your ILIT is also the beneficiary of the face value of the policy. Another feature of whole life policies is that your policy builds cash value over time that can be redeemed if you ever cancel your policy.
Because of its predetermined benefits, life insurance is also commonly used for key man insurance to insure owners or executives who are critical to the operation of a business. When used for key man insurance, a life policy is purchased by a business because their earnings may suffer after the loss of a single founder or executive.
Universal Life Insurance in an ILIT
Mechanically, universal life insurance has similarities to whole life. The biggest difference is that the size of a universal life policy can be adjusted by changing the size and schedule of premium payments. In this way, universal life offers many of the same benefits of whole life in addition to increased flexibility in payment of premiums.
Term Life Insurance in an ILIT
Term life insurance is also commonly used in irrevocable life insurance trusts. Unlike whole- or universal- life insurance, the death benefit of a term life policy is only temporary and available for a set period.
One of the biggest benefits to using term life insurance in an ILIT instead of whole- or universal life is that term life insurance is typically less expensive. However, it also doesn’t have a cash value that builds over time, so you don’t get any money back if you ever cancel your term life insurance policy.
“Although both term insurance and permanent life insurance can be used in an ILIT, choice of insurance policy will be largely determined by the age of the insured, premium for the life insurance, death benefit amount, and the policy duration necessary to effectively implement the estate plan. Note that larger premium payments gifted to the trust for a permanent policy also effectively reduces the taxable estate. In contrast, term policies might be cheaper initially, than a permanent life insurance policy, but might be unavailable or cost prohibitive at life expectancy when the life insurance is necessary.”
– Alex Kim, AVP of Advanced Markets, AXA
Irrevocable Life Insurance Trust Frequently Asked Questions (FAQs)
1. Can I Change the Beneficiary of an Irrevocable Trust?
The beneficiaries of the trust are defined at the time the trust is established. You can provide direction in the trust terms on distributions are made to beneficiaries and you can provide the trustee discretion in choosing beneficiaries. It’s generally not possible, however, for you to change the beneficiary of your irrevocable trust after it becomes effective.
In the case of an irrevocable life insurance trust it’s important to the trust must be the beneficiary of any life insurance policies held within the trust. While the beneficiary of the trust may change, depending on the terms of the trust, the beneficiary of the insurance policies should not.
2. Can Life Insurance be Paid to a Trust?
Yes, trusts can be the beneficiaries of estate planning life insurance. In fact, that’s precisely what an ILIT is and how it works – a trust buys a life insurance policy and is the beneficiary of that policy. The trust also pays all policy premiums.
3. Can You Change the Trustee of an Irrevocable Trust?
Yes. You can change the trustee of an irrevocable trust if the beneficiaries of the trust consent to the change. Without the consent of beneficiaries, however, it generally isn’t possible to change the trustee.
4. Are Life Insurance Proceeds Taxable to a Trust?
Kind of. The proceeds of life insurance policies are not taxable as income – either to trusts or individuals. If, however, interest is received as part of life insurance proceeds, then that interest income is taxable. One of the main points of an irrevocable life insurance trust is to protect your estate for tax consequences including the estate tax.
An irrevocable life insurance trust is an excellent tool, especially in succession planning, for the owners of family businesses and other closely-held companies. Using an ILIT allows you to structure the transfer of your assets to heirs and other partners while also avoiding some taxes including estate tax. To set up an ILIT properly we encourage you to work with a knowledgeable provider.
AXA Advisors is well-established and knowledgeable in helping clients understand what is an ILIT and to use these tools as part of their succession planning. AXA Advisors has more than 5,000 advisors nationwide who can help you choose from term-, whole-, variable- and universal life policies to structure an irrevocable life insurance trust that’s right for you. Visit them today to get started.
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