2890 N. Main Street, Suite 206 • Walnut Creek, CA 94597

The Importance of Life Insurance Trusts


The proceeds of a life insurance policy are included in the insured’s taxable estate at death. If the decedent’s taxable estate exceeds the federal estate exemption (currently $5.45 million), estate tax is due. For some, ownership of a large life insurance policy may trigger estate tax liability at death. An irrevocable life insurance trust can be a useful estate planning tool for those with assets approaching the federal estate tax threshold. An irrevocable life insurance trust (ILIT) is a trust that is set up to keep the life insurance policy proceeds out of an individual’s taxable estate. The life insurance policy is purchased by the trust and titled in the name of the trust. A properly executed life insurance trust can result in significant estate tax savings. Here’s some points to consider before contacting our office about an ILIT:

  1. How Insurance Trusts Work:

An attorney can help draft an irrevocable trust instrument. Once signed, you can transfer a life insurance policy into the trust, making the trust the policy owner.  The terms of the trust instrument will name a trustee, state how premiums will be paid, who the beneficiaries of the trust are and any conditions or terms for payment to beneficiaries.

Three Basic Requirements for an ILIT:

  • The trust must be irrevocable. Once signed, you cannot amend a life insurance trust;
  • You cannot be the trustee of the trust. You must name another individual or corporate trustee to serve as trustee. If you act as trustee of the trust the policy will be included in your taxable estate; and
  • To avoid deathbed tax avoidance, the IRS requires the trust to exist for at least three years before the grantor’s death.
  1. An Irrevocable Commitment

Perhaps the biggest drawback of an ILIT is that the trust cannot be changed or revoked once it is set up and funded. You cannot take the policy out of the trust once the trust is set up, although you can lapse or surrender the policy by ceasing to provide for premium payments. This means a ILIT is a big commitment!

  1. Beneficiaries Are Locked

The insured will designate the beneficiaries of the trust and include any requirements for distribution to a beneficiary such as age in the trust document. The trustee will distribute the proceeds of the life insurance policy to the beneficiaries upon the insured’s death. However, the irrevocable nature of a life insurance trust means the beneficiaries cannot be changed once the trust is set up.  This is a significant drawback for those with family situations that could change. Careful drafting can help avoid a situation where there is a failure of beneficiaries.

  1. No Loans

You cannot borrow against a policy owned by an ILIT because the insured is not the policy’s owner. The trustee can take out a loan but must consult with an attorney to make sure the loan will not expose the trustee to liability.

  1. You Must Survive the Transfer by 3 Years

The insured must survive the transfer of the life insurance policy to the trust by three years for the trust to be considered the owner of the life insurance policy. If the trust is not the owner of the policy the proceeds are included in the insured’s taxable estate. To avoid this, you can have the trust purchase the policy from the start, so there is no transfer and the trust is always the owner of the policy.

  1. Paying the Premiums

Paying the premiums of an ILIT without using up your estate and gift tax exemption is tricky. However, you may be able to exempt these premium payments from gift or estate taxes by setting the life insurance trust up as a Crummy Trust and using your annual gift tax exclusion (currently $13,000 a year per trust beneficiary) to pay policy premiums.

7. Naming a Trustee

Because one requirement of the ILIT is that the insured not control or own the policy, you cannot serve as trustee of your life insurance trust. A trusted family member, friend or advisor can serve as trustee. Naming a corporate trustee like a bank or financial institution is also an option.

Although a life insurance trust may seem complicated, life insurance trusts can provide substantial estate tax savings and ensure that your life insurance policy proceeds go to your beneficiaries with any limitations and specifications you choose. The formation of a valid and effective life insurance trust requires an experienced attorney.

2890 N. Main Street, Suite 206
Walnut Creek, CA 94597


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