Irrevocable Life Insurance Trusts (ILITs)
Irrevocable Life Insurance Trust and Estate Taxes
An irrevocable life insurance trust can be used to save on the
Federal Estate Taxes that
regular life insurance policies impose on the beneficiaries.
The proceeds of a life insurance policy are subject to Estate
or "death" taxes, which an irrevocable life insurance
trust can reduce or even eliminate.
For example, John Smith has an estate exceeding $3,000,000
when he dies, and the taxes on that amount to approximately
$675,000. To pay that tax burden, John took out a $1,000,000
life insurance policy, which he owns, with the intent that
his estate uses the proceeds to pay the estate tax. When John
Smith dies, that life insurance policy is itself subject to
an estate tax of 45-47%, leaving his heirs with only slightly
more than $500,000 to pay the remaining tax liability.
John Smith can get around this by not owning the life insurance
policy himself when he dies. The proceeds from the insurance
policy are normally not taxed when the policy is owned by
someone else. If someone transfers an existing policy and
dies within three years of the transfer, however, the proceeds
are subject to estate taxes. Any proceeds from a life insurance
policy are not subject to income tax, only to estate taxes.
If the policy on John Smith's life was taken out by another,
then the three year transfer rule does not apply. His children
could take out a life insurance on John, with them owning
the policy and being its beneficiaries. In that instance the
proceeds of the policy would not be subject to any estate
Another way around the estate tax is for the parties to establish
an irrevocable life insurance trust, which is merely an irrevocable
trust with a specific name. This trust is set up with the
children as the trust beneficiaries and one or more of the children
as trustees, and the trust is named as beneficiary of the life
insurance policy. Crummey provisions are put in the trust to
permit the annual gift exemption. The parents in this case,
annually gift the trust with enough money to pay the annual
insurance premium. The trust receives this cash gift and pays
the insurance premium, and any remaining funds can be invested.
When the individual or surviving parent dies, the trust receives
the proceeds of the life insurance policy and is not subject
to any estate taxes. When the trust terminates and its assets
distributed, they may be used to pay for the estate taxes
due on the other assets owned by the individual or surviving
The above example is simplified just to illustrate how careful
planning of life insurance can be used to lessen the estate
tax burden on survivors. THE MAMOLA LAW FIRM, APC is conveniently located throughout Orange County. For additional information, please contact us at (949) 333-6543.