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Do I Need an Irrevocable Life Insurance Trust if I Own a Life Insurance Policy?

Q: What is an Irrevocable Life Insurance Trust, and do I need one if I own a life insurance policy?
December 19, 2023
Home > Blog > Do I Need an Irrevocable Life Insurance Trust if I Own a Life Insurance Policy?

Q: What is an Irrevocable Life Insurance Trust, and do I need one if I own a life insurance policy?

A: An Irrevocable Life Insurance Trust, often referred to as an ILIT, is an estate planning tool that can help reduce, if not eliminate, an estate tax due at your death.

It is a common misconception that life insurance is not part of one’s taxable estate at death. This is not the case. So long as you remain the owner of the policy, the death benefit value will be included in your estate at death. By moving the policy to an ILIT, the trust takes ownership of the policy, and the policy’s value is out of your taxable estate.

The current federal estate and gift tax exemption is $12.92 million, and the New York State estate tax exemption is $6.58 million. Federally, an individual can gift up to $12.92 million during their lifetime or after death without incurring a federal estate tax. Additionally, the IRS allows you to gift $17,000 every year to individuals, which is not counted toward your federal lifetime exemption. It is important to note that the federal exemption is slated to sunset on January 1, 2026. This will bring the federal exemption back to pre-2018 levels, adjusted for inflation. Analysts expect the federal exemption will be somewhere between $5 million and $7 million.

Now, while the exemption is at a historic high, is the time to move money out of your estate. One way to do this is by putting an existing life insurance policy in an ILIT or purchasing a new policy to put in an ILIT. If moving an existing policy into an ILIT (assuming its value is over the $17,000 annual exclusion), a federal gift tax return must be filed for the transfer. Additionally, when the ILIT owns the policy, the trust will pay the premiums associated with the policy. You will first pay the money to the trust, and the trust will use the funds to pay the irrevocable life insurance trust premium payments. If the premiums are over $17,000, you will need to file a federal gift tax return on the money paid to the trust.

Irrevocable Life Insurance Trusts and the Three-Year Rule

A life insurance policy transferred to an ILIT must occur at least three years before the owner’s death because of IRC 2035(d). The IRS’s so-called three-year rule states that if the life insurance owner dies within three years after the transfer, the policy proceeds are includable in their gross estate. This defeats the aim of the irrevocable trust. If you do not yet own the policy, you can avoid the three-year rule by purchasing the policy directly in the name of the ILIT.

Call Today for Help with Drafting an Irrevocable Life Insurance Trust

An ILIT is a great estate tax planning tool for those whose estates are approaching (or may someday approach) six million dollars. Due to the complexities of drafting and funding such a trust, it is important to consult with an experienced estate planning attorney. ILIT is never created piecemeal but is part of a comprehensive estate plan.