Managing Your Wealth Through Irrevocable Life Insurance Trusts

Last updated on: May 30, 2024

There may be a need to reconsider your plans for passing generational wealth to your heirs since the federal estate tax exemption allowance appears to be in danger of being reduced. Senate Democrats are proposing to lower the current estate tax exemption from $12.06 million to $3.5 million for individuals and $24.12 million to $7 million for couples. Whether this particular Congressional bill will pass into law is unknown; however, change is likely coming to estate tax exemptions. Even without action by Congress, in 2026, the current rate will sunset and essentially be cut in half to about $6.6 million per individual.

Secure your financial future with the help of a Houston trust attorney. At The Law Office of Whitney L. Thompson, our dedicated attorneys can be your trusted allies in understanding these important financial tools. We can assist you with ILITs and create a robust plan for your estate. Contact us at (281) 214-0173 to secure your family’s financial well-being.

What Is A Life Insurance Trust?

A life insurance trust is a legally structured legal arrangement that serves as a strategic tool for individuals with substantial wealth. It plays a pivotal role in reducing estate taxes during the transfer of life insurance policies. These trusts serve as an integral component of an individual’s estate planning strategy, ensuring financial security for their loved ones in the event of an untimely passing. However, it’s important to note that life insurance proceeds may be liable to taxation, which could reduce the final amount that beneficiaries receive.

Establishing a life insurance trust offers numerous benefits, including:

  • Estate Tax Reduction: The primary aim of setting up a life insurance trust is to minimize estate taxes. By transferring a life insurance policy into the trust, the policyholder effectively removes it from their taxable estate. This strategic move results in substantial tax savings for their heirs.
  • Controlled Asset Distribution: In situations where a life insurance policy pays directly to beneficiaries, those beneficiaries gain full discretion over how to utilize the proceeds. In contrast, a life insurance trust grants the policyholder to establish specific guidelines regarding the timing and manner in which the policy proceeds are distributed.
  • Creditor Protection: A life insurance trust can shield the policy proceeds from potential creditors. This protection becomes crucial for individuals with a high net worth or those exposed to significant liability risks.

When it comes to securing your family’s financial future, a life insurance trust can be a crucial component of your estate planning. At The Law Office of Whitney L. Thompson, our Houston trust attorney can assist you in navigating the intricacies of establishing and managing a life insurance trust. With our extensive knowledge and experience in estate planning, we can assist in creating legal instruments that help you protect your assets and your loved ones even after you’re gone. Contact us today to schedule a consultation.

Benefit Description
Estate Tax Reduction Minimize estate taxes by transferring life insurance policy into the trust, resulting in substantial tax savings.
Controlled Asset Distribution Establish specific guidelines for timing and manner of distributing policy proceeds, providing control over assets.
Creditor Protection Shield policy proceeds from potential creditors, particularly beneficial for individuals with high net worth.

Understanding Irrevocable Life Insurance Trusts and Other Taxations

To address additional inheritance taxation, many look to an irrevocable life insurance trust as a mechanism to reduce estate tax and pay your heirs part or all of the amount your estate will be taxed. The asset of the trust will be one or more life insurance policies. However, beware, as once an irrevocable life insurance trust (ILIT) is created, it cannot be rescinded, modified, or amended. There are several important requirements to create and maintain an ILIT properly, and each requirement helps to explain the nature of such a trust.

  • If you are the trust grantor, you cannot also serve as a trustee because a trustee controls the trust, leading to the trust being considered a part of your estate. It is crucial to name a trusted person or financial institution to act as a responsible trustee.
  • The trust itself must be the owner of the life insurance policy. If you transfer an existing policy to the trust and die within three years of the transfer, the policy is part of your estate due to a look-back rule. The trust can directly purchase a policy to avoid this risk.
  • The trust must pay the policy premiums, and you must transfer funds to the trust for such a purpose. This situation can create an issue with gift taxes as a transfer to a trust is not usually afforded the yearly gift tax exclusion of $16,000. To qualify as a gift for a tax exclusion, the recipient must have a “present interest” in the money. To accommodate this requirement, you can use what is known as “Crummey” power, giving beneficiaries the ability to withdraw funds transferred to the trust for up to thirty days. Sending a Crummey letter to the beneficiaries of an ILIT informs that a gift has been made to the trust, and there is an immediate and unrestricted right to withdraw those assets for up to thirty days. After thirty days, the trustee can pay the annual insurance premium with the funds. Although you run the risk that the beneficiaries will withdraw these funds, if you make it clear the financial benefit is greater in the future, it should not present a problem.
  • Generally, the beneficiary of the life insurance policy is the trust. After the funds are deposited into the trust, the trustee can distribute the assets to the beneficiaries as specified in the trust. If your beneficiaries are still minors, you can instruct the trustee to wait until they reach a certain age. Leaving the assets in the trust can also protect them from beneficiaries’ creditors.

ILIT’s can own both individual and second to die life insurance policies. All premium payments should come from a bank account owned by the ILIT. The downside to an ILIT is that it is irrevocable. However, your ILIT is a powerful tool that can minimize your estate taxes, avoid gift taxes, protect assets and government benefits, select the timeline of distribution to beneficiaries, and more. If you would like to discuss whether an ILIT may be right for you, give us a call. Please contact our Houston office at 281-214-0173 or the Bay City office at 979-318-5079 today and schedule an appointment to discuss how we can help you with your legal matters.

What are the Disadvantages of an Irrevocable Insurance Trust?

Setting up an irrevocable life insurance trust (ILIT) involves several significant disadvantages that potential trust creators should carefully consider:

  • High Costs: Establishing an ILIT can be expensive. It typically requires the experience of an estate or trust attorney to draft the trust documents correctly. This process can cost thousands of dollars, not including ongoing administrative fees and the costs associated with appointing and compensating a trustee.
  • Inflexibility: Once established, an ILIT is nearly impossible to alter or revoke. This rigidity means that if your circumstances or intentions change, you cannot modify the trust to suit your new needs. For example, you cannot transfer the life insurance policy out of the ILIT if you decide it would be better managed elsewhere or if a more favorable financial strategy arises.
  • Complexity in Setup and Management: The process of setting up an ILIT is complex. It requires a thorough understanding of estate planning, IRS regulations, and trust law, which can be overwhelming for many individuals. This complexity often necessitates ongoing professional advice and management, which can be both stressful and costly.

While ILITs can offer significant estate tax benefits, they come with high costs, a lack of flexibility, and management complexity. These factors make them less suitable for some individuals, highlighting the importance of thorough planning and advice when considering this estate planning tool.

At The Law Office of Whitney L. Thompson, our experienced Houston trust attorneys are here to help. We understand the complexities and unique challenges that come with managing these types of trusts. We can guide you in setting up an irrevocable life insurance trust tailored to your specific financial goals. Contact us today at (281) 214-0173 to explore how we can help you protect and manage your wealth effectively.

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