Benefits Of An Irrevocable Life Insurance Trust ( ILIT )

Benefits Of An Irrevocable Life Insurance Trust ( ILIT )

| March 07, 2024

What’s interesting is that while many people think that Life Insurance is tax free, the reality is it’s not.  Life insurance is income tax free but it’s not Estate Tax free.

Life Insurance is considered an asset and thus subject to Potential Estate taxes because Estate Taxes are based on the transfer of an asset.  So, when you transfer something to someone besides your spouse, you may have to pay taxes on that.

Now there is an exemption against Estate taxes which in 2024 is $13.61 million for each person and with portability, that means a husband and wife can shelter twice that amount meaning together almost $27.22 million can be sheltered from Estate taxes. 

Obviously, few people in America have that high of a net worth and are worrying about paying Federal death taxes.  However, each state can also have their own death taxes on top of the Federal one and the thresholds can be different. 

For instance, in IL, death taxes start at $4 million, not $13.61 million and there is no portability meaning a husband and wife don’t automatically get to double their exemption amounts. And if your net worth is $1 above that $4 million threshold, then the entire $4 million gets taxed.

So when you add the 40% Federal Estate tax and then the potential State death taxes on top of that, your heirs could lose almost 45% or more to taxes. I’m sure none of you, when you were filling out your beneficiary form on your life insurance policy, put down the IRS as your 45% beneficiary.  Probably not.

Here’s where proper estate planning can help.  A potential solution is to create an Irrevocable Life Insurance Trust and you put your life insurance policy into that trust. The goal is then to have that asset not be included in the value of your estate and that’s why an Irrevocable Trust is used. 

There are 3 stipulations however that the IRS needs to see to make sure your life insurance is not included in your estate:

Are you the Life insurance payer?  If you’re paying the premiums, then you are considered the owner and it fails the test.

Do you have incidence of ownership, meaning can you change who the beneficiary is or access the cash value, etc.? If you can do those things, then you are showing ownership and fail the test.

And lastly, are you actually the named owner on the policy? That’s a simple one. If you are, again you fail! 

Also bear in mind that you don’t have to fail all 3 of those. As long as you fail just one of those, the Life insurance will be calculated in your estate and subject to taxes.

In order to pass the IRS stipulations, you would create an Irrevocable Life Insurance Trust, you put the policy into that trust, you name the trust as owner and you make the trustee whoever you want to have incidence of ownership, just not you, and voila, the life insurance is no longer part of your estate.

Now if you do this with an existing policy that you have, there’s a 3-year look back rule, meaning if you die within the 3 years, it will still count as part of your estate.

But with a new policy after the trust is created, it will avoid the 3-year rule.  So, in the end, an ILIT is a great tool for removing the life insurance policy from your estate and thus not subjecting that death benefit to potential death taxes.

 Disclosure Advisory services are provided by Apollon Wealth Management, LLC (“Apollon”), an investment adviser registered with the Securities and Exchange Commission. Piershale Financial Group is a DBA of Apollon. The information in this message is for the intended recipient[s] only. Please visit our website for important disclosures