What is an irrevocable life insurance trust and is it right for you?

The estate tax is a tax that is not always on the top of people’s mind.  However, here in Massachusetts, we have a 1 million dollar exemption, which is much lower than the 5 million dollar federal exemption.  Therefore, planning to avoid estate taxes affects more middle class people in Massachusetts than elsewhere. 

When calculating the estate tax, any assets in the decedent’s name will be used in the calculation.  Sometimes the biggest asset, and most forgotten asset is the life insurance death benefit.  Even though the decedent will never benefit from the policy, if the policy was owned by him when he passed away, then it will be included in his estate tax calculation.

Life insurance policies have a variety of purposes, such as income replacement, funding a buy/sell agreement and providing for dependents, such as young children and family members with disabilities.  These purposes can drive up the death benefit to ensure that loved ones are taken care of financially. 

A common misconception about life insurance is that it is tax free.  There are many different types of taxes, and the death benefit from a life insurance policy is income tax free, but it is not estate tax free.  What an irrevocable life insurance trust or an “ILIT” does is remove the policy from the decedent’s estate, and therefore it is not included in his estate tax calculation.  Therefore, for some middle-class individuals, an ILIT can completely eliminate their tax liability. 

While the concept of having an ILIT for a life insurance policy seems simple, there are many complex aspects that go into drafting and administering an ILIT.  We strongly advise speaking with an estate planning attorney regarding your options and whether this is a trust for you.