What Parents Should Know About Irrevocable Life Insurance Trusts

Life insurance is an essential part of estate planning for most people. Whether you have a large policy that will provide for your loved ones long after you are gone, or a more modest policy that is meant to help cover all your final expenses, it is important to ensure your loved ones get as much of the money as possible. What many people don’t realize is that when your loved ones receive the life insurance payout, it can be a taxable event. Since it will quickly and dramatically improve their annual income, it can bump them up to higher tax brackets and end up requiring them to pay most of this money to the IRS. Fortunately, there are ways to avoid this without violating any IRS rules or regulations.

Irrevocable Life Insurance Trusts

An irrevocable life insurance trust, or ILIT, is a type of living trust that is set up specifically to be the beneficiary of your life insurance policy. This way the payout goes into the trust rather than directly to your loved ones. You would then designate your spouse, adult child, or other individual to be the trustee of that trust.

Once the ILIT is created you won’t be able to change it or revoke it on your own because it is an irrevocable trust. If it were revocable, it would be considered an asset of yours by the IRS and would then become a part of your estate, which could trigger estate tax issues. This is why it is so important to ensure it is set up properly, and the beneficiary is chosen correctly to minimize any expenses.

Benefits of an ILIT

When you pass away with an ILIT named as the beneficiary of your life insurance policy, all the money from that policy will go into the trust. The trust would then payout the person or people you specify on a schedule that you decide upon creation. For example, if you have a $1 Million policy that goes into an ILIT with your spouse named as the beneficiary of that trust, you could set it up to pay your spouse $50,000 per year until the money is exhausted. This way your spouse’s’ taxes won’t shoot up in the year of your death and your heir can have a reliable source of income.

If your spouse passes away before the money in the trust is exhausted, you can specify a secondary beneficiary such as a child or children. It is important to consider all your options and set up the trust in the best way to get the results you desire.

Sooner is Better

It is important to understand that if you die within three years of setting up this trust with an existing life insurance policy, the IRS will look at the life insurance payout as part of your estate even though it is in the trust. If you don’t already have a life insurance policy, you can create the trust, and then fund it with enough money to pay for a new life insurance policy’s premium, and have the trust take out the policy. This will prevent the IRS from looking at it as part of your estate even if you pass away within three years. To get your ILIT started and discuss the best steps for your situation, contact us today to schedule a consultation.

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