Using Irrevocable Trusts to Eliminate Estate Tax on Insurance

Irrevocable Trusts, “ILIT” – short for Irrevocable Life Insurance Trust – are created to own life insurance policies. The significant advantage of having insurance policies owned inside an ILIT is that the death proceeds are not included in the insured’s taxable estate upon his death. Further, the death proceeds are not taxable in the surviving spouse’s estate, even though she has access to the proceeds to maintain her lifestyle. Upon the death of the surviving spouse, the proceeds pass tax free to the children or beneficiaries of the insured’s choice. Consider this example: Dad and Mom have a taxable estate. They need life insurance in the event Dad prematurely dies. He purchases a $2 million policy. Upon the second death of Dad and Mom, if Dad owns the policy the children may receive only $800,000 because of 40% federal estate taxes. If Dad’s Irrevocable Trust is the owner and beneficiary of the policy, upon his death the proceeds are available for Mom, but yet at Mom’s death if she has not used the funds, pass to the children estate tax free. Sometimes ILIT’S are drafted to own insurance on both spouses so that the insurance pays off at the second death when estate tax is owed. These so-called “second to die policies” or “survivorship policies” are almost always owned by ILIT’S because there is an existing estate tax problem, and you do not want to add to the estate tax problem with the death proceeds. With 2019 federal estate tax exemption amounts of $22.8 million for a married couple, not many taxpayers are concerned with estate tax. But for those exceeding $22.8 million, irrevocable insurance trusts are still a necessity. ILIT’S may again become more relevant if a future President and Congress reduce the estate exemption amount.