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You’ve worked hard to build wealth and provide for your loved ones. Life insurance can be an important estate planning tool, and when properly structured within an irrevocable life insurance trust (ILIT), the policy’s proceeds may be excluded from your taxable estate. An ILIT can also provide greater control over how and when beneficiaries receive funds. To determine whether this strategy aligns with your goals, contact the Arizona estate planning attorneys at Pennington Law, PLLC for a free consultation.
How Can a Life Insurance Trust Help Protect Your Wealth and Legacy?
An irrevocable life insurance trust (ILIT) is a special type of trust that owns a life insurance policy instead of you owning it personally. This structure can help keep the life insurance payout out of your taxable estate.
Here’s how it generally works:
- You create the ILIT.
- The trust buys a life insurance policy (or you transfer an existing policy to it).
- When you pass away, the insurance company pays the policy proceeds to the trust.
- The trustee then manages and distributes the funds according to the instructions you set in the trust document.
After your death, the trustee can use the funds to help your family cover expenses, provide financial support, or help with business succession. In some cases, the trust can provide liquidity so your loved ones don’t have to quickly sell property or business interests to cover estate costs.
Because the trust is irrevocable, you generally give up control of the policy once it is placed in the trust. That loss of control is what may allow the life insurance proceeds to stay outside of your taxable estate.
An ILIT is not necessary for every estate, but it can be a helpful tool for families who want to preserve wealth, create structure around inheritances, or plan for estate taxes.
Why Are Life Insurance Trusts Especially Important for High-Net-Worth Families?
Families with substantial assets are more likely to be subject to federal estate taxes, depending on the size of the estate and laws in effect at the time of death. An ILIT provides tax benefits by keeping life insurance proceeds outside of the taxable estate. It can also provide funds to cover estate taxes or other expenses.
Another critical reason high-net-worth families may benefit from an ILIT involves gift tax planning. Each year, you can contribute money to the trust that you intend to declare as a gift. These contributions may also qualify for the federal annual gift tax exclusion.
To qualify for the exclusion, you or the trustee must send a Crummey letter to the beneficiary. This notice advises the beneficiary of their right to withdraw the contribution. The beneficiary typically has a limited period of time to make the withdrawal, usually 30 to 60 days. If the beneficiary chooses not to withdraw the funds, the funds remain in the trust and are used in accordance with its terms.
When structured and administered properly, this strategy allows families to fund life insurance inside the trust while minimizing gift tax exposure and potentially reducing estate tax liability.
How Can an ILIT Help Reduce or Eliminate Life Insurance Estate Tax Issues?
When you own a life insurance policy, the payout is typically included in your taxable estate when you die. This increases the size of your estate for estate tax purposes.
However, an ILIT functions differently. Because the trust owns the policy, any proceeds from the payout go to the trust, not your estate. This can help prevent the insurance payout from increasing your estate tax exposure and can provide funds to support your family or help cover estate-related costs.
How Are Survivorship Life Insurance Policies Used in Life Insurance Trusts?
Your ILIT can also own a survivorship life insurance policy, also known as a “second-to-die” policy. These policies insure two people, usually spouses, and only pay out after the second spouse passes away.
Survivorship policies are useful tools in estate planning because federal estate taxes are generally assessed after the second spouse’s death. With funds placed in an ILIT, the trust receives the proceeds and can provide funds when needed to cover taxes and related expenses.
In some cases, survivorship life insurance policies may be easier to obtain than two separate policies, especially if one spouse is in poor health. Couples who want to leave money to their children can make use of a survivorship policy to help cover potential estate taxes after both pass away. Funds could also be used to provide care for dependents with special needs, such as adult children. With a careful estate planning strategy, an ILIT can be a valuable tool for providing financial security to those you leave behind.
When Should You Consider Creating a Life Insurance Trust?
You may want to consider an ILIT as part of a comprehensive estate planning strategy if:
- You want to minimize federal estate taxes – Arizona currently has no estate tax.
- You want to protect your wealth and provide for heirs – By potentially reducing your taxable estate value, an ILIT can preserve more estate assets for family members and heirs.
- You own a business – An ILIT can provide funds to support business succession planning, helping your business remain operational during the transition after you pass.
- You have dependents with special needs – Funds in an ILIT can be structured to provide ongoing support to a disabled dependent without jeopardizing their eligibility for government benefits like Medicaid.
How an Arizona Trust Attorney Can Help
There is no one-size-fits-all estate plan, and your needs will vary based on your financial situation and personal circumstances. Our award-winning attorneys have years of experience in creating comprehensive estate plans focused on asset protection, wealth management, and peace of mind.
The estate planning lawyers at Pennington Law, PLLC can help with your ILIT by:
Reviewing your current life insurance policies to confirm their suitability
Drafting trust documents that meet Arizona’s legal requirements and are legally enforceable
Coordinating with your insurance agent to transfer policy ownership
Setting up a Crummey notice process for gift tax compliance
Updating the trust should your life or goals change
Recognized as a Client Champion Platinum by Martindale-Hubbell and an AV Preeminent-rated firm, our legal team has also been featured in publications including Forbes, The New York Times, Super Lawyers Magazine, and USA Today.
