The Irrevocable Life Insurance Trust – Part I

elder law lawyersThe irrevocable life insurance trust is an estate tax saving device. Federal estate taxation begins after the estate has $5,340,000 in it.  New York State Inheritance taxes apply to estates that are over $1,000,000.  The proceeds of life insurance policies are exempt from state and federal income taxation but these proceeds are included in the individual’s estate for estate tax purposes. So how do you get to avoid state and federal estate taxes on life insurance proceeds? You put the life insurance policy into an irrevocable life insurance trust. An irrevocable life insurance trust is also referred to as an ILIT.

ILIT Example

To understand the importance in the appropriate situation of utilization of an irrevocable life insurance trust, let’s look at the following issues. Federal estate taxation on estates over $5,340,000 taxes those funds at a 35% rate. The New York State inheritance tax rate on funds over $1,000,000 in the estate is at approximately 16%.  If you add the 16% New York State Inheritance Tax rate and the 35% federal tax rate, you are paying 51% of the funds being inherited in taxes. A life insurance trust allows the inheritance of life insurance proceeds and avoids this 51% double taxation rate.

How The Life Insurance Trust Works

To start with, you cannot own the policy. The life insurance trust must purchase the policy from the insurance company and own the policy. This means you will have no control over the life insurance policy during your lifetime. This is important because the Internal Revenue Service (IRS) requires that you give up control of the policy for the policy to avoid estate taxation. This means you cannot change the beneficiary of the policy. You also cannot borrow against the policy. However, you can name whoever you want as the beneficiary of the trust when the trust is purchased. Since the trust is an irrevocable trust, you cannot act as the trustee.

Paying the Premium

irrevocable trust attorneyEven though you don’t own the policy, you still pay the premiums on the policy. As of 2014, you can make gifts of up to $14,000 per year to any one person or entity. Therefore you can pay up to $14,000 per year to the trust to pay life insurance premiums. As long as you do not pay more than $14,000 per year, as of 2014, there are no tax issues.