A life insurance trust, often called an ILIT, is a trust that holds your life insurance policy. It controls how the death benefit is paid out after you are gone, and it can save your family six figures or more in estate taxes if you have a large policy.
What Is a Life Insurance Trust (ILIT)?
An irrevocable life insurance trust is a separate legal entity that owns your life insurance policy instead of you owning it personally. When you die, the policy pays the death benefit to the trust, and the trustee distributes it according to the terms you wrote into the trust. Because the trust owns the policy rather than you, the proceeds are not counted as part of your taxable estate. That single fact is what makes an ILIT worth doing.
Why Life Insurance Proceeds Are Taxed When You Die
Most people do not realize that life insurance proceeds become part of your taxable estate when you die. While the insurance payout is not income taxable, it is estate taxable. You might not look wealthy while you are alive, but when you die the life insurance proceeds are added to your other assets to work out your taxable estate, and your family can be over the line without ever feeling rich.
Why the Massachusetts Estate Tax Threshold Matters
Massachusetts taxes estates at a far lower threshold than the federal government does. For people who die on or after January 1, 2023, Massachusetts allows a credit that eliminates the estate tax on estates valued at $2 million or less. Above that figure, the estate is taxable. A modest house, a retirement account and a term life policy can add up past $2 million faster than most families expect. Estate taxes can eat away at an inheritance in a big way here, and without a trust the policy itself can end up paying the very tax it created.
How an ILIT Keeps the Policy Out of Your Taxable Estate
A life insurance trust removes the value of the life insurance proceeds from your taxable estate. The trust applies for and owns the policy, you make gifts to the trust to cover the premiums, and the trustee pays them. Because you never own the policy and hold no right to change the beneficiary or borrow against it, there is nothing for the estate tax to attach to. Having a life insurance trust in place can mean your loved ones receive the full benefit of the policy instead of watching part of it go to tax.
You Decide How and When Your Family Gets the Money
When you die, the policy pays out according to the trust terms that you choose. If you have young children, you can spread the payments over time rather than hand a teenager a lump sum. If you are divorced and have young kids, you can put control of the funds in the hands of a trustee of your choosing, rather than your ex. Those controls come with a trust. They do not come with a beneficiary designation on the policy.
The Trust Is Irrevocable, and That Is the Point
A life insurance trust has to be irrevocable. Once it is signed and the policy is in it, you give up the right to change it, cancel it, or take the policy back. People sometimes hear the word irrevocable and stop there, but that surrender of control is exactly what keeps the proceeds out of your estate. A trust you could undo whenever you liked would not do the job. It also means no one can alter your wishes after your death.
The Three-Year Rule on Policies You Already Own
If you transfer a policy you already own into a new trust, federal law pulls the proceeds back into your taxable estate if you die within three years of the transfer. The cleaner approach is usually to have the trust apply for and own a new policy from the start, so the three-year clock never begins. If an existing policy does have to be moved, it needs to be done with that rule in front of you.
This is an advanced technique, and it should not be handled by attorneys who “dabble” in estate planning. Do it wrong, and it is all for nothing.
If you have a large life insurance policy and nothing holding it but a beneficiary designation, it is worth finding out what that would cost your family.
Book a free 15-minute consult call with our Lead Intake Coordinator, Nicole Ott, or give us a call at 978-657-7437. There is no charge and no pressure. The goal is simply to work out what your family actually needs to do next.
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