Although it may sound like something you use when texting your friends, an ILIT is actually an irrevocable life insurance trust. An ILIT is a type of trust that is funded during your lifetime by a term or permanent life insurance policy and pays out proceeds of the policy upon the insured’s death. Since it’s irrevocable, the trust generally cannot be changed or revoked unless the premiums of the insurance policy held in the trust are not paid, causing the policy to lapse.
Benefits of an ILIT
When applying for Massachusetts Medicaid (MassHealth) eligibility to pay for long-term care, the cash value of your life insurance policy will be included by MassHealth as a countable asset (if more than $1,500). Transferring the policy to an ILIT will shelter the cash value from your future long-term care needs. However, the act of transferring the policy will trigger the 5-year look back period for eligibility purposes.
If you are the owner of an insurance policy, the death benefit will be included in your gross estate. In Massachusetts, if your estate is over $1 million, the whole estate is subject to estate taxes. An ILIT allows you to avoid having the death benefit of your policy included in your gross estate and therefore, not subject to Massachusetts or Federal estate taxes.
Avoiding gift taxes
Establishing an ILIT enables you to fully leverage the annual gift tax exclusion ($17,000 in 2023) and avoid gift tax consequences. There are certain requirements to maintain the ILIT status such as, sending out annual letters to the beneficiaries, known as Crummey Letters, notifying the beneficiaries of the trust and of their right to withdraw. After 30 days, the trustee can use the contributions to pay the insurance premiums and, in most cases, avoid the need to file a gift tax return.
Liquidity to the estate when it’s needed
Funding an ILIT can provide critical funds to help pay expenses of the estate, including estate taxes, after you die. That allows your loved ones or business partners to avoid having to sell assets to cover these expenses.
Discretionary power to make distribution
A properly drafted ILIT can give the trustee discretionary powers to pay out the insurance policy proceeds immediately or to make distributions for important life events, like to pay for college, a first house, having a child, etc. This is especially useful for blended families where the decedent wants to ensure the life insurance proceeds go to his or her children or if the beneficiary of the proceeds is a minor.
Not disrupting government benefits
Distributions from insurance policies owned by an ILIT can be managed to not disrupt any government benefits a beneficiary may be receiving. This is especially beneficial for any trust beneficiaries who may be on government assistance programs, such as Medicaid or SSDI.
An ILIT has additional benefits including protecting your insurance benefits to your beneficiaries from creditors, lawsuits, and divorce. ILITs also avoid having to go through probate.
Potential Pitfalls of an ILIT
With the good comes the bad. The primary downside to an ILIT is that no change can be made once the trust is signed and funded with the life insurance policy. The grantor (person funding the trust) gives up all rights to the property in the trust, including any changes to the trust beneficiaries and any conditions as to how the trust beneficiaries receive the assets. The grantor will also give up direct access to the cash value of the policy in the future.
Properly drafted ILITs are a powerful tool that can provide you and your loved ones with many significant benefits. It’s equally important to work with a competent estate planning attorney and financial planner to make to make sure one is right for you.
Founded by a nurse attorney and with offices in Acton, Sudbury, and Andover, Massachusetts, Generations Law Group helps families navigate the complex areas of estate planning and elder law to inform and protect loved ones of every generation.