Article by
Jeffrey
N. Zisselman, J.D.
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Jeff Zisselman
Irrevocable Life Insurance Trust
An irrevocable life insurance trust (“ILIT”) is a specific type
of irrevocable trust. Typically, an ILIT provides for distribution
of trust income and/or trust assets to or for the benefit of the
grantor's spouse and children. The trust can also be an indirect
source of liquid funds to the grantor's estate. Ownership of a life
insurance policy (usually on the grantor's life) is vested in the
trust.
There are two basic types of ILITs – funded and unfunded. A funded
trust is, just as its name suggests, funded with income-producing
assets in addition to one or more life insurance policies. All or
part of the income generated within the trust may be used to pay
premiums on the life insurance policy. One consequence of using
a funded trust to purchase the life insurance is that, to the extent
trust income can be used to pay premiums on life insurance policies
on the life of the grantor or the grantor's spouse, the grantor
will be taxed on trust income.
An unfunded ILIT has as its sole asset a life insurance policy,
usually on the grantor's life. No income-producing property is available
to provide funds to pay premiums. Consequently, in order for the
trustee to pay premiums, the grantor must make annual gifts to the
trust. From an income tax standpoint, both trusts have the same
result - the grantor will have paid income tax on the money used
by the trust to pay the insurance premiums.
However, there is a difference in the gift tax results between
an unfunded and a funded trust. In the case of an unfunded trust,
gifts are made each year to enable the trustee to pay the annual
premium. Depending on the size of the annual premium, it is possible
to qualify the full amount of the gifts for the federal gift tax
annual exclusion. In the case of a funded trust, a substantially
larger gift will be required at the onset in order to generate sufficient
income within the trust to pay future premiums. Consequently, it
may be more difficult to qualify the gift for the annual exclusion
with the result that a taxable gift may be made.
An ILIT is primarily an estate tax savings tool. It can be drafted
in such a way that the trust assets, including policy proceeds,
will be excluded from both the estate of the insured and the estate
of the insured's spouse. This can be accomplished even though the
spouse of the insured benefits from the trust assets while he or
she is alive. This advantage would not be available if the insured
or the spouse owned the life insurance directly. The trust may hold
policies on the life of one spouse, or both, or it may hold a Survivor
Joint Life policy. A properly drafted trust will allow the insurance
proceeds to escape taxation at both spouses' deaths.
In addition to saving estate taxes, an irrevocable trust has other
advantages. It may be incorporated into a comprehensive estate plan
to provide a means of estate liquidity and/or family income. The
trust may also make use of the services of a corporate trustee to
aid in investment and income planning decisions.